Death Care Law Blog : Kansas Death Care and Preneed Lawyer & Attorney : Stalter Legal Services Law Firm : Funeral Law, Elder Law : Kansas City

The Special Deputy Receiver for NPS recently reported the company’s “negative net worth” to be just short of one billion dollars. Rightfully, regulators are looking at the NPS fiduciaries for culpability in the losses that will be sustained by consumers and funeral homes in the years to come. In the meantime, Missouri state officials are working with industry representatives to reform Chapter 436. As they consider how to better safeguard consumers’ funds, regulators and legislators need to appreciate that preneed sellers and fiduciaries have overlapping responsibilities that are affected by a state’s trusting requirements. 

In states with lower trusting requirements, the preneed seller typically assumes responsibility for individual preneed contract accounting. Besides the ability to report to consumers, this function is also crucial to the fiduciary’s income tax reporting. In states with higher trusting percentages, the trust often assumes greater responsibilities for the accounting and reporting functions. 

Historically, preneed laws have restricted preneed trust expenses to the fee that was typically charged by banks or trust companies for estate planning business. Some state laws also restrict the trustee’s ability contract with the preneed seller for administrative services.   While restrictions are needed to avoid a circumvention of the trusting requirements, more latitude should be afforded the fiduciary. In exchange, preneed sellers and fiduciaries should be required to make disclosures about those who provide the trust services, and the fees paid for the various services. 

The Texas Department of Banking and the Texas Funeral Directors Association broached these issues ten years ago.    In Opinion 98-15, the TDOB found that the preneed trustee fees could be used to pay for marketing expenses, outside recordkeeping for preneed contracts, and investment advice. (It is generally recognized that the trustee can incur expenses for trust accounting, legal expenses and tax reporting on behalf of the trust.)

 Eventually, Texas may review its preneed law in light of the fraud committed on its consumers and funeral directors by NPS. I suspect NPS exploited the Texas provisions allowing for a depository.   Before eliminating the authority to use the depository arrangement, the Texas legislature needs to appreciate the difficulty the industry has in attracting quality fiduciary services.   

Allowing the trust to bear the expense of compliance does not come without the risk of abuse. Services must be necessary to the trust, and reasonable in cost. One check against such abuse would be the requirement that services must be performed pursuant to a contract with the fiduciary. Transparency of the relationships among the parties, and the fees paid could serve as another check.   The IRS will likely require such transparency within the next few years as fiduciaries are required to ‘unbundle’ their fees for income tax reporting purposes.

Eventually, we may see death care fiduciary fees being broken down by the following services:

Asset management (investment)

Sub account administration

Tax reporting

Legal (contracts/compliance)

Legal (liability/litigation)

Custodial services

Regulatory and consumer reporting

Marketing

Ten years later, the TDOB opinion may be dated in terms of what constitutes a reasonable fee. Sub account administration can run as high as 85 basis points. Asset management fees will differ on the manager’s expertise, and 50 basis points is a fairly common fee. Tax reporting expenses can differ substantially based on the diversification of the trust assets.   Distribution oversight may require periodic examinations, and the expense that accompanies on-site reviews. Periodic statements to consumers and regulators will require administrative enhancements. However, economies of scale are crucial to minimizing these costs, and pooled administration will be key to providing the requisite economies of scale. Several years ago, the Office of the Comptroller of Currency recognized the role national banks could play in meeting the needs of the death care industry.

The death care trust is a different breed of animal from a bank’s staple trust business of estate planning.   Consequently, legislators need to allow fiduciaries to contract for those services crucial to enhancing the compliance that the preneed transaction so desperately needs.

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It is encouraging when funeral directors and consumer advocates engage in meaningful debate about the future of Missouri's preneed industry.  And, there seems to be some consensus that the non-guaranteed contract should have a greater presence in the state. 

In the third of six scheduled meetings, industry and consumers were faced with those prickly issues of the trusting percentage, income accrual and portability.   While there were no resolutions, progress is being made.

There will be consumers who want to lock in a prearranged service, whether it is for price or because the individual has made a decision.   But what about the consumer who wants to start the prearrangement process and is not quite sure. 

The Missouri Funeral Directors and Embalmers Association broached the issue with a proposal that may have flaws, but provides a starting point for discussion.   In the discussion that ensued at the July 24th Review Committee meeting, it was suggested that the non-guaranteed account could be used as a hybrid form of preneed: where the prearrangement would not be finalized until 'everyone' was ready.  

Amen, Rev. Stroud.

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Here is a twist on the “Another theft from a death care trust”: this one does not involve a cemetery operator or a funeral director. Last week, an Indiana grand jury indicted a banker, an investment advisor and an attorney. What may sound like the beginning of a joke that most funeral directors and cemeterians can relate to, this story actually involves a trio of fiduciaries who worked with both Clayton Smart and Robert Nelms.  

Prior industry reporting helps connect the dots between David Becher, Mark Singer and Sherry Katz-Crank.  Ms. Katz-Crank is the co-founder and general counsel for Security Financial Management Company, a Michigan firm. Mr. Becher was an officer with Community Trust & Investment, an institution based in Noblesville, Indiana. Mr. Singer worked for Smith Barney in Philadelphia. 

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What happens when the family opts for a cremation at the time of need when the preneed contract provides for a traditional funeral?  If the preneed contract was purchased in a spend down situation, the funeral director and the family may be caught in a Catch -22.  Many states' laws preclude the refund of the funds to the family. 

Missouri law (RSMo 208.010.4) provides that if a preneed contract beneficiary was receiving public assistance, any cancellation or amendment of a preneed contract will result in the amount in excess of the cost of the funeral being refunded to the state (up to the amount of the benefits received).  Kansas law imposes a similar requirement on the funeral home to refund the excess to the state.  A Kansas Attorney General opinion states this is even required in the absence of a contract amendment. 

These laws have the effect of inducing the family to spend up rather than allow the funds to go back to the state. 

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Regulators and preneed sellers squared off recently over the subject of who owns the preneed trust fund: the funeral home or the consumer. Hearings to reform Missouri’s preneed law hit a wall when the issues of trusting requirements, income accrual and portability was taken up by a review committee comprised of regulators, industry representatives and consumers.  

In a debate that has been waged in countless other venues, several Missouri funeral directors asserted that the trust fund is theirs because they have guaranteed the prices and assumed the risk of the trust's performance.   The regulators argue that the trust fund represents the consumer’s funds, and the consumer should have the right to change their minds about funeral homes and type of service they want, and to do so they must be able to transfer the funds or receive a refund without penalty. 

This all begs the question: what do consumers want?  We cannot answer that question in Missouri because the law only contemplates the guaranteed contract. 

Mortuary Management asked the question whether the guaranteed contract is necessary to attract preneed customers.  As was the case at the Missouri meeting, the responses were divided. 

As Missouri re-writes its preneed law, consumers should be afforded a meaningful choice between the guaranteed contract or the non-guaranteed, 100% funded contract.  As I wrote in one of the first blog entries, the non-guaranteed contract faces certain hurdles.  

Under Missouri's current trusting requirements, preneed sellers have little incentive to offer a non-guaranteed contract.   If the funds are deemed to be entirely the consumers', who will assume the burden of establishing a program that provides the requisite documents, administration and oversight?   

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It was once fairly common for a funeral director to take a preneed purchaser's funds and establish a joint account at a local bank.  Missouri's preneed law contemplates the transaction and requires that the funeral home and the purchaser have joint control over the account.  Prior to 9/11, banks would freely provide account forms, allowing the funeral director to obtain the purchaser's information and signature at the funeral home.  However, the security requirements imposed on banks by the USA Patriot Act have probably made the joint account an impractical method to funding a preneed contract. 

A few years ago, banks were required to implement programs to collect more information about their customers and to verify their identities.  The purpose of these new requirements was to prevent money laundering that could involve the financing of terrorism. 

What this means to the funeral director is that he/she can no longer prepare bank account applications at the funeral home.  All parties to the account must be present at the bank when the account is opened.  I have encountered one bank that interpreted the Patriot Act to prohibit the joint account arrangement contemplated by Missouri law.  

While the joint account provided a funding mechanism to funeral directors who did not have the volume of preneed business to warrant the expense of trusting or insurance, there are ample indications the arrangement has been abused and may need to be discontinued.  An unknown number of funeral homes have rolled joint account contracts to NPS.  Unwittingly, some funeral homes have combined multiple contracts in a single certificate of deposit, exposing the consumers' funds to the claims of the funeral home's creditors.  

As states seek to respond to the NPS failure by tightening preneed laws regarding trusting and insurance, consideration must be given to how a safe and affordable preneed arrangement can be offered to the rural consumer.  

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So why is it so tough to provide preneed portability?   Because the transaction has been defined by state law as a contract between a consumer and a death care company, and federal regulators tend to agree.   When the issue has arisen in the context of federal preemption, the interests of the state regulator have prevailed on the grounds the transaction is ‘local’ in nature, and the state has an overriding interest in policing the transaction. This perception permeates federal oversight of the preneed transaction, including that provided by the Internal Revenue Service and the Securities Exchange Commission. So long as preneed is defined as a guaranteed contract for goods and services, complete portability will be difficult to achieve.

Consumer advocates view the preneed transaction as a savings account to be safeguarded until the death, and some state laws accommodate that perception. Kansas requires 100% trusting, an accrual of income and assures portability by granting the purchaser the right to designate a different funeral home to perform the contract.

However, if the Kansas contract was written by a funeral home with its own preneed trust, there has to be a trust agreement between the original funeral home and the fiduciary. Despite what the law states, the new funeral home is not bound to that trust agreement. In the absence of a trust agreement, the fiduciary does not want the responsibility of ensuring the new funeral home performs the preneed contract according to its terms. If the new funeral home seeks to have the funds transferred to its own bank, what responsibilities does the trustee have to ensure the receiving institution will accept the funds in a fiduciary capacity? (Is anyone familiar with Bremen Bank?) 

So long as the new funeral home is within the state of Kansas, the state’s preneed law could be revised to afford the fiduciary some protections. However, state law will not remedy the situation where the consumer has moved to another state. 

When faced with this situation, insurance companies protect themselves by adopting policies that restrict policy assignments. It is not that uncommon to encounter insurance companies that prohibit policy ownership by funeral homes. Insurance companies will be more lenient with funeral homes with whom they have an agency relationship.

For states like Missouri, portability faces the challenges of the seller/provider distinction and lower trusting requirements. Missouri allows preneed sold by third party entities, and requires the seller to have a contract with the funeral home or cemetery prior to marketing to consumers. In keeping with this requirement, regulators recently looked at language to improve portability. However, that result was confusing, and did not consider the fiduciary issues. The Pennsylvania State Board of Funeral Directors had similar experiences with a recent effort to address portability. 

If a Missouri contract has been trusted using the minimum requirements, the contract becomes less attractive to other funeral homes as time passes from its sales date. There may come a time when the contract becomes a liability.  Under that circumstance, the consumer will have difficulty finding a funeral home willing to accept the contract. 

The irony of the NPS failure is that the company’s program offered the consumer interstate portability that only the national death care companies could match.   But the NPS customers have not only lost the portability of their contracts, some face the prospect of their named provider going out of business. 

Steps can be taken to improve portability, but it will not be as simple as mandating a result. Increasing funding requirements and assuring insurance assignment rights will help. To overcome resistance by funeral directors, protections against ‘twisting’ could be offered. 

However, if the consumer wants complete portability, he or she will need to consider the non-guaranteed preneed contract. 

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Before the guaranteed preneed contract, funeral directors accepted pre-payment on funeral arrangements as an accommodation to their families. Funds were typically placed in a joint account or POD account at the local bank. As this practice became more common, “preneed’ laws were passed to establish requirements regarding the deposit and withdraw of funds. These laws were fairly simple, and some can still be found in many states’ preneed laws as a separate section within the more complex provisions intended for the guaranteed contract.

The guaranteed funeral contract was created about 50 years ago, and preneed took on a predatory characteristic. Promoted primarily by third party preneed programs, the guaranteed funeral contract became a tool for the funeral home that sought to compete with the more established funeral home across town. To overcome the ‘heritage’ established over years of service to a community, a funeral home offered the guaranteed contract to families to reduce expense and emotional distress. 

The third party preneed programs introduced concepts that early preneed laws did not contemplate: master trusts, diversified investments, commissions and grantor tax treatment. Over time, preneed was defined by the guaranteed contract, and the transaction proved very divisive for the funeral industry. A majority of funeral directors felt preneed was harmful to the profession and sought to deter the transaction. Realizing that this form of preneed was dependent upon salesmen, the trusting requirement became a pivotal issue. (Investment restrictions became another.)

With regard to trusting, preneed sellers took the position that the transaction represented a sale of goods and services and the trusting requirement should be set to cover the costs of providing the contracted goods and services. Many funeral directors countered that preneed was an accommodation and that joint account/POD funding requirements should apply to master trusts as well. Funeral directors adverse to preneed understood that if all consumer payments had to be trusted, preneed sellers would be deprived the revenue needed to compensate salesmen. Legislative battles were waged from state to state during the 1970s and 1980s (at a time when insurance funding did not play a major factor). The result was a mixed bag of state laws that vary greatly as to preneed trusting requirements. 

Generally, the 100% trusting issue surfaces in states such as Missouri, Nevada and Texas when consumer advocates pushed reform by seeking increased trusting requirements. However, the issue took on a different light recently when legislation was introduced in Tennessee to reduce its trusting requirement from 100% to 90%. While the bill eventually failed, the Tennessee Funeral Directors Association has good reason for pursuing the change even in light of the NPS failure.

NPS’ climb to become the nation’s largest third party preneed seller was fueled to a great extent by Missouri preneed sales. Missouri’s law allowed NPS to keep the first 20% of the consumer’s payments, and to withdraw income earned by the trust. Consequently, the NPS failure will lead to a call for Missouri to raise its trusting to 100%. Consumer advocates are recommending that Missouri legislators use New York’s preneed law as a guideline. New York not only requires 100% trusting, it also prohibits insurance funded preneed. While these restrictions have worked to the benefit of New York’s consumers and funeral directors, it is too late to implement such restrictions in Missouri (and the other states affected by NPS).

The New York Funeral Directors Association has an excellent record with consumers, and provides innovative programs to both consumers and funeral directors.   The Association’s preneed master trust provides crucial funding for those programs and services. While the state’s size would be sufficient to guarantee a large master trust, the Association also benefits from a legal environment that precludes competition from insurance companies and most outside third party sellers. (It should also be noted that the NYFDA master trust, like so many other state association master trusts, is also a third party preneed seller.) 

Through services provided to its master trust, the NYFDA generates revenues that underwrite educational materials, contracts, marketing, legal expenses and individual account administration. As the primary obligor of its preneed contracts, the association is also in a position of authority to its funeral homes.   The freedom from meaningful competition has allowed the NYFDA to make the consumer and compliance its top priorities. Funeral homes that do not agree with the Association’s policies have few preneed alternatives. In a sense, restraint of trade has worked well for the New York consumer. 

While preneed will always have its detractors, a majority of funeral directors now understand that preneed is more than an accommodation. However, the expense of establishing a preneed program is too great for many funeral homes. Consequently, the state master trust provides the necessary economies of scale to make preneed affordable for the smallest establishments. But, establishing a New York style preneed program requires commitment, time and resources. Without a substantive trust to fund program features, state master trusts must look to current sales for revenues to underwrite education, contracts, compliance, administration, and taxes. But as the Tennessee Funeral Directors Association found out a few weeks ago, it is very difficult to overcome the point of view that preneed is an accommodation and that 100% trusting constitutes a ‘good’ preneed law.

Beyond the 100% trusting requirement, the NYFDA is the only association that does not also have to contend with insurance company competitors. Even though insurance provides the consumer an important alternative to trust funded contracts, this competition impacts an association’s ability to effect policies that may be unpopular with some funeral directors.   If the cost of participation in the master trust must be borne in part by the member funeral homes, some mechanism must be afforded the funeral home to recover those costs when the contract is canceled or transferred to a non-member funeral home. This may be a consideration in the pending Ohio legislation. 

It is unfair to compare the New York master trust to those in states such as Missouri and Iowa. Missouri’s state association had to compete with 3 preneed sellers and several insurance companies. As a consequence, the MFDEA cannot dictate issues to its members as the NYFDA can. Any attempt to implement New York styled restrictions in states such as Missouri will likely be challenged by insurance companies and proactive preneed funeral homes to the FTC as unreasonable restraints of trade. 

Clearly the 1980’s argument advanced by preneed sellers about trusting has been proven wrong by the NPS failure. It is not enough to simply trust that amount needed to cover the ‘cost’ of the prearranged funeral.   Rather, legislators must find a way to protect consumers’ interests while providing the death care industry the means to pay the costs of a preneed program that provides education, performance, compliance and safety.

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Although it may not be apparent from the press release or the final Decision And Order, the FTC proceeding against the Missouri State Board of Embalmers and Funeral Directors has restraint of trade implications for future efforts to regulate the preneed transaction. 

The focus of the FTC inquiry was on the State Board’s lawsuit against an individual who sold caskets. The State Board’s proceedings indicate that the individual did more than sell caskets. While it was never the State Board’s intent to preclude non-licensed entities from selling caskets, the strategy taken by the Board’s attorneys relied upon Chapter 333, the law that governs the licensing of embalmers, funeral directors and funeral establishments. Eventually, the matter came to the attention of the FTC, and its focus was on Chapter 333 and the regulations promulgated there under. In Missouri, preneed is regulated under Chapter 436, and the FTC documents made only passing reference to Chapter 436.

Concurrent with the FTC investigation, a cemetery client was struggling with how to comply with the section of Chapter 436 that restricts the entities or individuals that can contract to perform a preneed contract in Missouri (Section 436.015.1):

No person shall perform or agree to perform the obligations of, or be designated as, the provider under a preneed contract unless, at the time of such performance, agreement or designation:

(1) Such person is licensed by the state board as a funeral establishment pursuant to the provisions of section 333.061, RSMo, but such person need not be licensed as a funeral establishment if he is the owner of real estate situated in Missouri which has been formally dedicated for the burial of dead human bodies and the contract only provides for the delivery of one or more grave vaults at a future time and is in compliance with the provisions of chapter 214, RSMo; and

(2) Such person is registered with the state board and files with the state board a written consent authorizing the state board to order an examination and if necessary an audit by the staff of the division of professional registration who are not connected with the board of its books and records which contain information concerning preneed contracts sold for, in behalf of, or in which he is named as provider of the described funeral merchandise or services.

In essence, R.S.Mo. §436.015.1(1) states that no person shall agree to perform the obligations of a preneed contract provider unless such person is licensed by the State Board as a funeral establishment pursuant to the provisions of section 333.061, RSMo. An exception is allowed for cemeteries to provide vaults.

Prior to filing a comment with the FTC, clarification was sought from the State Board that the law was unenforceable. Knowledge that Chapter 436’s ambiguities were already being exploited by preneed sellers, the State Board eventually declined to make an exception for the law.  

In finalizing the proceeding against the State Board, the FTC issued a letter in lieu of revising the Decision and Order.   Though directed at the State Board, the message conveyed is that state law cannot restrict who may sell or deliver a casket, whether it is at-need or preneed. 

One approach to providing better control over the preneed transaction is to license the seller. Preneed abuses warrant tighter control over the transaction, but caution must be exercised with regard to: 1) the restrictions imposed on who can sell preneed (or obtain a preneed license), 2) the definition of the preneed contract, 3) recovery of cost restrictions and 4) contract and/or advertising restrictions. (I will get to the latter  restrictions in upcoming blog entries.)

Ohio walks a fine line with regard to restraint of trade issues through its restrictions on preneed sales. Ohio has claimed that preneed should be limited to licensed funeral directors, and proposed legislation attempts to salvage this approach by limiting the restriction to preneed contracts that include funeral services:

 Sec. 4717.31. (A) Only a funeral director licensed pursuant to this chapter may sell a preneed funeral contract that includes funeral services. Sections 4717.31 to 4717.38 of the Revised Code do not prohibit a person who is not a licensed funeral director from selling funeral goods pursuant to a preneed funeral contract; however, when a seller sells funeral goods pursuant to a preneed funeral contract, that seller shall comply with those sections unless the seller is specifically exempt from compliance under section 4717.38 of the Revised Code.

(The Ohio legislation provisions that relate to preneed and insurance agents warrant discussion in a separate blog entry.)

Restricting the preneed sale to licensed funeral directors has merit, and the support of some consumer advocates. However, this approach has problems other than the restraint of trade issues. 

Beyond the explanation of funeral, cremation and burial issues, preneed involves financial, legal and tax considerations. For states that do not require continuing education, the funeral director has little exposure to the ‘business’ aspects of the transaction.  

The restriction is also difficult to reconcile with the weekly report of funeral directors who have failed to properly handle consumer funds. 

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