Death Care Compliance Law

Death Care Compliance Law

Preneed: A Pandora's Box of Problems

William Stalter is the founder of Stalter Legal Services and the Preneed Resource Company. Bill focuses his law practice on preneed and death care compliance, serving banks, funeral homes, crematories, and cemeteries. He has written multiple published articles

Missouri Audits: What’s in store for round 2?

Posted in Compliance, Exams/audits, Missouri - SB1

The Missouri State Board of Embalmers and Funeral Directors will meet August 4th and 5th to discuss legislation, regulation drafts and changes to the examination process.  The State Board examiners are completing the first audit of each preneed seller, and the scope and procedures for the next round of preneed audits will be discussed.   Use the following hyperlink to down load the State Board Open Agenda Material.

Preneed Trust Shortages: Investment Management Fees

Posted in Associations, Compliance, Investments, Master Trusts, Missouri - SB1

One strength of the state association master trust is that it can provide the ‘critical mass’ required for economies of scale to reduce trust management costs.  As the state master trust grows in size, the association can better negotiate asset management arrangements.  However, the reality has been very different for these programs.  The reorganization of the each of the Wisconsin Master Trust and the California Master Trust cited the need to reign in high investment management costs.

Investment management fees can include mutual fund expense ratios, ETF expense ratios, advisor fees, brokerage fees, transaction fees, load fees and 12b-1 fees.  (To learn more about investment expenses follow this hyperlink to a Bloomberg Business article: An Investor’s Guide to Fees and Expenses)  When management fees are not controlled, expenses can take a heavy toll on the fund return.  (Follow this hyperlink to a Forbes magazine article: The Heavy Toll Of Investment Fees).

In a prior post (Accountability and the Master Trust  ), we explained how the state master can provide the smaller funeral home the economies of scale necessary to reducing costs that would otherwise be prohibitive.  But as we noted in that post, transparency and accountability to funeral home members and consumers is lacking on the part of some state association programs.

Master trust programs should provide the following information:

  • The name and address of the trustee.
  • The master trust’s written investment policy.
  • The fees paid to the trustee, fund managers and account administrators.
  • The taxes paid by the trust.
  • A summary report of the trust’s performance and asset description.
  • A disclosure of related party transactions (loans, discounts, service agreements, etc.)
  • Any sponsorship fee paid the association.

In another prior post (Un-parking those death care trusts: diversification) we discussed how poor investment performance by preneed trusts can be blamed in part on the lack of active fund management.   When the program’s investment policy consists of offering a few mutual fund options to the funeral director to choose from, one has to question whether the program is meeting its fiduciary duties to funeral directors and consumers.

Missouri Funeral Trust: Seeking a Gag Order

Posted in Associations, Master Trusts, Missouri - SB1

On July 27th, a Missouri court will consider a motion filed by the Missouri State Board of Embalmers and Funeral Directors to be dismissed from the lawsuit filed by the Missouri Funeral Trust.  One of the allegations made by the Missouri Funeral Trust was that confidential information obtained by a state auditor regarding the program’s weaknesses have been communicated to participating funeral homes by a competitor.  The Missouri Funeral Trust has requested the court to order the State Board to cease auditing the program until all sensitive information and documents can be properly protected.  But what is rather odd about the lawsuit is that the Missouri Funeral Trust has not alleged that the information or documents purportedly being leaked to MFT members is either inaccurate or fraudulent.  So, the MFT is suing to be the sole source of information to its program members.

The Missouri lawsuit should seem a bit of déjà vu when one considers that it was 9 years ago when Minnesota regulators forced that state’s master trust to be disbanded.  The Minnesota Funeral Trust could not earn enough to pay its expenses, which resulted in the Minnesota Department of Health and the association battling over the information that was to be provided to the program’s funeral home members. In the end, the association was forced to enter a Stipulation and Consent Order, and to provide certain information to its members.  Individual funeral homes also signed consent orders that allowed them to assume control of the trust funds sold in their name.

The request for a gag order has some asking whether the Missouri Funeral Trust also has secrets it wants to hide from its members.

Preneed Trust Shortages: Deposit Plus Accounting

Posted in Administration, Compliance, Legislation, Missouri - SB1

During its state convention, the executive director for the Missouri Funeral Director and Embalmers Association stated that their master trust program would have a $3 million dollar surplus if all preneed contract beneficiaries were to die that day.  If the Missouri program were being administered pursuant to common trust fund rules, there should not be any surplus under the facts stated by the program’s executive director.  All assets would have been distributed by the trust to the servicing funeral homes.  One can only conclude from the statement that the Missouri program relies on tax cost accounting for the individual ‘value’ of each preneed contract.

In two prior posts (Consumer Options and Administrative Hurdles: Market Value Allocations and Nebraska’s Push to Market), we discussed tax cost accounting and master trust programs.   Tax cost accounting can be described as tracking deposits plus realized income.  This type of accounting does not reflect unrealized gains and losses.  So when a trust has significant unrealized losses, tax cost accounting results in performance distributions that exceed a contract’s share of the assets’ fair market value.  Each performance distribution digs the program’s hole a little deeper.

Since the Missouri Funeral Trust’s claim of a 5% surplus, the investment markets have been rocked by the insolvency of Greece and the volatility of the Chinese stock market.   These events only add to the general uncertainty caused by the Federal Reserve’s plan to begin raising interest rates.   The Missouri program could still have a ‘surplus’, but it may now be razor thin.  And, that ‘surplus’ will not be uniform to all preneed contracts.   When the Fed begins raising rates, any portfolio holding long term bonds will experience market value declines.

When a master trust program uses tax cost accounting for contract values, or any basis other than fair market value, who has the liability for trust ‘shortages’ caused by performance distributions that exceed a contract’s fair market value?  In Illinois, the trustee was forced to assume a portion of the liability, but funeral homes will bear the remainder with each contract they service.

The Missouri Agenda: a few clean up provisions

Posted in Missouri - SB1

The Missouri State Board of Embalmers and Funeral Directors will meet to July 21st to discuss “a short slate” of legislation and regulation proposals.   While many of the proposals have been previously discussed, some, such as the preneed shortage funding requirement, are new.  We also note regulation proposals regarding when forms and reports are deemed filed, requirements for external/independent investment advisors and the formation of an insurance funded contract.

Tuesday’s meeting may last longer than an hour.

Preneed Trust Shortages: Missouri’s Income Withdrawals

Posted in Exams/audits, Investments, Legislation, Master Trusts, Missouri - SB1, Recordkeeping, Reporting, Trust Funded

Prior to Missouri re-writing its preneed law in 2009, preneed sellers could draw off realized income so long as the withdrawal did not reduce the trust’s fair market value below trust deposits.   Seeking income, many Missouri sellers directed their trustees to invest in bonds.  As interest rates declined during the early part of the prior decade, bonds with higher yields climbed in value.  However, replacing those yields with new bonds became difficult, and then impossible (with the subprime mortgage collapse in 2008).  A trustee would have to pay a premium for a bond with the rate that sellers sought.  Today, many of Missouri’s older preneed trusts are left with a cupboard of long duration, lower yield bonds that are very susceptible to market volatility.  When the Federal Reserve does eventually begin to raise interest rates later this year, bonds with longer durations will experience a fair market value erosion.  If an older Missouri preneed trust has a resulting ‘shortage’, that exposure will likely be due to a trustee having sit on a bond portfolio while the seller continued to pull out interest income.  This is primarily an old trust problem because the new law now requires income to be accrued until the cancellation or performance of the contract.  (Sellers that combined their pre and post SB1 contracts in the same trust may have another set of problems.)

It has not been our experience that the financial examiners seek information to determine if a seller’s trust has been making income distributions, and how the trustee documents compliance with the prior law’s “mark to market” requirement.  Such distributions could be documented with the trust’s current fair market value, gross income year to date, gross trust expenses year to date, any reserve for income taxes, income distributed year to date, and the income to be distributed.

So long as the seller and trustee appropriately apply the brakes to income distributions before the fair market value hits the deposit balance, a subsequent shortage resulting from a market decline should not trigger the seller’s liability to contribute funds.  Failure to anticipate the market’s decline, could leave the trust in a prolonged shortage that could require future distributions to be based on fair market value (ie, on the performance of a contract, sellers would receive less than the contract’s deposit balance).

Missouri and Preneed Deficiencies: What is a shortage?

Posted in Legislation, Master Trusts, Missouri - SB1, Preneed Shortfalls, Reporting, Trust Funded

At its June meeting, the Missouri State Board of Embalmers and Funeral Directors gave instructions to their staff to draft legislation that would provide the Board powers to force preneed sellers to contribute funds to their trusts to cover ‘shortages’.   The instruction was not without some controversy as one Board member questioned why he was required by his preneed examination to fund shortages from preneed contracts that he had assumed through a funeral establishment acquisition.  The explanation of “it depends on the acquisition document” provoked some confusion.   Through the discussion by the Board, the staff and the public, it was generally agreed that the seller is not a guarantor of investment performance, and therefore should not be responsible to fund market value drops.  But, as witnessed by other states’ master trust problems, there are a score of other sources for trust ‘shortages’.  Consequently, the staff’s attempt to define those ‘shortages’ that a seller will be held liable for funding will come under close industry scrutiny.  And based on comments offered by its executive director at the state convention, the Missouri association’s master trust may be at the front of the line to voice objections.

Intended as demonstrations of strength, a convention audience was advised that if all Missouri master trust contract holders were to die that day, the program would be left with a surplus of about $3 million dollars.  And, if all contracts were to cancel that same day, the program would be left with a surplus of about $7 million dollars.  Any statement that suggests a common trust fund would have a ‘surplus’ warrants  regulators’ questions, but we will explore those issues another day.  However, if the cancellation ‘surplus’ and representations made about the size of the trust’s assets ($63 million) are accurate, then the program likely has a significant number of individual preneed contracts with a fair market value near  their deposit balance.   But, the association master trust will not be the only Missouri seller with preneed contracts that are on the cusp of a “shortage”.

The first round of Missouri preneed financial examinations is now being completed and our experience with seller clients has been their examination reports seek an explanation for each contract that has a market value below the required deposit balance.  This can be particularly frustrating when the ‘shortages’ are on small number of contracts that amount to a few dollars each.  These inquiries may reflect either a lack of understanding by the examiners, or a lack of adequate trust information.  Consequently, it may be time to look at the different sources of trust shortages and the information provided by sellers and trustees, and then to establish guidelines for the next round of preneed financial examinations.

Association Master Trusts: De Facto Trustees

Posted in Compliance, Exams/audits, Fiduciary, Investments, Master Trusts

According to court filings, the reorganization plans for the Wisconsin Master Trust and California Master Trust each seek to eliminate ‘de facto trustee’ relationships that allowed the respective associations’ executives to ‘misuse, misspend, and mismanage millions of dollars’ of trust funds, and to direct funds towards inappropriate and unsuitable investments that served the association’s, rather than the beneficiaries’, goals.   The receiver for the Wisconsin Master Trust laid responsibility for abuses of that trust at the feet of the association, and reported to the court that:

The Trust was hemorrhaging from the costs it was incurring. We promptly eliminated between $50,000 and $100,000 per year in administrative costs, $125,000 per year in investment advisor fees and $240,000 per year in payments to the WFDA and its affiliate. We also eliminated a large amount of other fees that did not appear on the Trust’s records but that were built into securities transactions.*

The trust agreements proposed to courts in California and Wisconsin would reinstate the trustee’s duties with regard to investment compliance, controlling trust expenses, and to severe the association’s use of master trust funds.  Consequently, it seems odd that executives for the Missouri Funeral Trust would use the circumstances of the Wisconsin and California master trusts to distinguish their own program, and to then file a lawsuit declaring confidential and proprietary all trust documents, client lists and investment contracts.  Sources report that while attending the Missouri Funeral Directors and Embalmers Association convention a few weeks ago, master trust representatives declared the program had “deep pockets” and could afford to sue to protect its interests and client relationships.  If trust assets are being used to finance the lawsuit, the State of Missouri may legitimately inquire whether the Missouri program also has a de facto trustee.  Since Missouri’s preneed financial examinations are not structured to drill for hidden investment costs and inappropriate trust expenditures, the MFT lawsuit seems to be inviting further scrutiny of the trustee by the Division of Finance and the Federal Deposit Insurance Corporation.

*The hidden fees the receiver refers to are 12b-1 fees that the association allowed fund managers to collect off various mutual funds.  Those types of fees are often in addition to basis points fees charged by the fund managers.

Transparency:The Curious Case of the Missouri Funeral Trust

Posted in Master Trusts

In his final report to the court, the Wisconsin Master Trust receiver proposed a new trust agreement that is intended to provide “transparency, accountability, oversight and prudence”.   Similarly, the California Attorney General seeks to provide transparency through express reporting requirements included in the trust agreement proposed to the court presiding over the California Master Trust.  The proposed California Master Trust agreement would provide more program information to the state regulator, funeral homes and trustors/contract purchasers.  Funeral homes were included in the beneficiaries for transparency because the master trust programs often operated in secrecy to participating funeral homes.  Funeral homes participating in the Illinois master trust were not informed of how the trust invested, or that key man insurance was frequently purchased on owners’ lives without their knowledge.  With three large state master trust programs having been forced to provide greater transparency, it is curious to see a state master trust bringing litigation claiming that information concerning its members, investments and agreements are proprietary and confidential.

On May 22nd, the Missouri Funeral Trust filed a lawsuit against the State Board of Embalmers and Funeral Directors and Catholic Holy Family Society seeking an injunction to protect various program documents and information as confidential.  Catholic Holy Family Society is an insurance company that writes preneed insurance policies, and it hired away from the State Board, an auditor that had handled the examination of the Missouri Funeral Trust program.  For 4 years, the Missouri Funeral Trust has been the subject of a preneed financial examination, and the complaint alleges this gave the auditor unfettered access to program information, including strengths and weaknesses, and which funeral homes might be prime targets for a competitor company to ‘steal away’.  The lawsuit was disclosed to Association members and industry attendees to the Association convention, with an explanation that the Missouri Funeral Trust has very deep pockets and can pursue litigation against any competitor that solicits MFT board members.

Curiously, what is not alleged in the complaint is that the defendants misrepresented any information communicated to program members.  The main message communicated by the lawsuit, and by program representatives, is that the program’s executives should be the sole source of information to the member funeral homes.  This rings a little too familiar with what happened in Wisconsin and Illinois.

State Master Trusts: Plans of Reorganization

Posted in Master Trusts, Preneed, Trust Funded

Two of the country’s largest association ran master trusts now have pending plans of reorganization.  On May 14th, the receiver appointed for the Wisconsin Master Trust filed a Final Report that outlined to a court his proposal for the reorganization of that program.  On May 22nd, a hearing was held in a California on the Attorney General’s proposal to reorganize the master trust established by that state’s funeral directors association.  Both proposals substantially alter the relationships among the funeral directors association, member funeral homes and the master trusts.  Over the next few weeks we will examine the changes made to these master trusts.