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

The U.S. Government Accountability Office (GAO) released its latest report on the state of state regulation of the death care industry.  As it did in 2003, the GAO selected a handful of states to review in depth, and Illinois was one of those states for 2011 report.  The Illinois review is set out as Appendix IV of the GAO report, and paints a bleak picture of preneed oversight in the Land of Lincoln. 

The Illinois review advises that the Office of the Comptroller has 10 staff positions and 10 field audit positions to provide supervision of preneed and crematories.  While it is the Comptroller’s intent to audit each preneed seller at least once every five years, budget constraints have limited audits to those businesses with the most preneed.  Otherwise, the Comptroller will target sellers based on annual reports that either reflects ‘abnormal fluctuations’ or the lack of a corporate trustee. 

And when the Comptroller does find problems, her staff complains that the law provides them little power to address the situation.  The GAO was advised that the disciplinary process is extremely slow and costly.  That latter comment should raise some eyebrows in Illinois.  It was the Comptroller’s office (albeit a prior officeholder) that pushed through amendments to the Funeral or Burial Funds Act just a short two years ago, and now the staff claims the law has no teeth.

The Illinois review ends with the Comptroller’s office on the defense.  Industry representatives challenged whether the Comptroller’s 2010 legislation provided any additional protections.  The Comptroller responds that “there is no way to be sure if the changes to the laws would have prevented these kinds of incidents, but that there may have been the ability them earlier”.  (Obviously someone left out a few words, but they also failed to confer across the hall with that other someone who was more honest about the law’s lack of teeth.)

The review concludes with the statement “[F]urther, state regulators in Illinois stress the importance of consumer education and whistleblower protections to help prevent and detect future problems.”  If the Comptroller lacks funding and enforcement powers under the current law, who is fooling who?  Can additional legislation be too far away?

 

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Every funeral director has faced the situation where Mrs. Smith comes in with an insurance policy and her funeral plans. Often, Mrs. Smith has gone to trouble of designating the funeral home as the policy beneficiary before having discussed her plans with the director. Often funeral directors file the policy and plan away until Mrs. Smith’s time of need. Frequently, the file includes nothing more than Mrs. Smith’s policy and funeral preferences, and this is troubling for Missouri’s new preneed audit staff.

Although Missouri’s preneed reforms went into effect more than 2 years ago, the new examination process has gotten off to a slow start. The first hurdle was funding. The new law imposed a $36 per preneed contract fee. New licensing fees were also imposed. However, these fees were tied to annual reports and renewals that were not due until October 31, 2010.

The Division of Professional Registration has also had the task of hiring preneed examiners and establishing audit guidelines. Defining those audit guidelines has proven difficult due to fact Missouri has hundreds of funeral home sellers that have been operating with little regulatory input or oversight for 25 years. Consequently, every single examination poses its own unique issues. But the one issue that must be surfacing with regularity is Mrs. Smith and her insurance policy.

After ‘practicing’ on the State Board’s industry members, the examinations began in earnest this past summer. By the Board’s September meeting, Mrs. Smith and her insurance policy were on the agenda. The staff floated a proposed regulation regarding a definition of preneed that would trigger Chapter 436 reporting requirements when Mrs. Smith walked through the funeral home’s door. Once the funeral director was put on notice of the insurance beneficiary designation, he must either report it or take action to reverse the designation.

The staff’s reasoning is that a contract has formed when the funeral director is put on notice of the policy designation. That contract is for a funeral arrangement that is not immediately needed, and therefore falls within the definition set out in Section 436.504(7). The staff further argues that this interpretation is needed to protect the consumer when the only evidence of the contract that exists was a ‘handshake’. While the staff has a point regarding the risks of the handshake, this transaction falls outside the legislative intent of SB1.

SB1 regulates the industry’s ‘sale’ of preneed contracts where consumer funds are paid to the funeral home or cemetery. The law’s intent is to make sure the preneed seller deposits those funds to trust or a joint account, or pays them to an insurance company. In contrast, Mrs. Smith may have purchased her Prudential Life policy from the same agent who sold her car and home insurance.

But, the staff’s concerns are not without merit. If Mrs. Smith’s children do not know of either the insurance policy or the handshake with the funeral director, they may go to another funeral home. The staff also asks what it is to stop the funeral director from retaining the insurance proceeds when the family has gone to a competitor.

To ensure Mrs. Smith’s wishes are fulfilled, the funeral home should document the policy designation with a written contract (which provides for a return of the proceeds if a different funeral home is used). The contract should also spell out the promises with regard to prices.

However, Missouri consumers would be better served if SB1 fees were spent towards audit procedures that focus on preneed sales, and not Mrs. Smith and her insurance policy. Missouri’s Chapter 333 provides the State Board with authority to implement additional protections when the funeral director accepts an insurance policy in exchange for a handshake.

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Our preneed provides peace of mind by freeing your family from the burdens of rising funeral costs and from making difficult decisions during their time of grief.

Since the inception of the transaction sixty years ago, that statement has defined preneed marketing. Even the AARP recently embrace the peace of mind concept. The inflationary protection that can be provided by preneed is the product of the guaranteed contract through which, funeral homes assumes the risks of investment returns and cost increases. But unless today’s consumer can afford to pay for that guaranteed preneed contract with a lump sum payment, the most popular form of preneed funding is forcing many families to choose cremation.

In 1988, insurance moved to the forefront of preneed funding by virtue of a tax ruling adverse to preneed trusts. While insurance was already a major player in the preneed industry, insurance companies had followed the lead of the early preneed pioneers by crafting a product to be used with the guaranteed contract. In the twenty years that followed the tax ruling, preneed insurers built sophisticated programs around their guaranteed contract policies. To win the funeral home’s business the insurance product must provide a commission (to pay preneed program expenses), an increasing death benefit (to offset the increase in costs to service the contract), preneed contract forms and regulatory reporting. The costs of these features are most apparent in the pricing of installment premiums.

Using costs discussed in our prior post, assume a husband and wife (age 67) want to purchase average funerals, opening and closing services and a grave marker. The total costs are approximately $20,000.00. That is a hefty sum for a couple on a fixed income.

The premium rates charged by preneed insurers vary due to factors such as the funeral home’s volume of business written, the commission rates sought by the funeral home, the age and health of the consumer, the term of installments, and the method of invoicing. For purposes of this post, we averaged two of the leading preneed insurer’s premium rates and assumed premium invoices would be mailed to the consumer. The attached chart reflects the monthly premiums for installments over 3 years, 5 years and 10 years. The chart also reflects the total cost of the premiums to the couple.

Most elderly consumers would be hard pressed to make monthly payments of $330, let alone $740. And if the couple elects the 10-year installment plan, the total cost of the original $20,000 package almost doubles. Not much of a cost savings.

Like most consumers, the preneed buyer will begin to ask what can I purchase with $80 (or even a $100) a month. The resulting death benefit will be about enough for two cremations.

If the industry wants to keep the traditional funeral affordable, more flexibility is needed in the funding of preneed. The price guarantee (and the purchase of insurance) may have to be deferred until the consumer (or funeral home) can afford it.

 

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Here in the Midwest, the death care industry is just beginning to experience the increase in preneed reporting and oversight. Some funeral directors are already frustrated with the new requirements, and are biding the time to when they can vent towards the preneed regulator.

Over the past 4 years, state agencies in Illinois, Kansas and Missouri were made to account for their roles in the failures of preneed programs. The replies were very similar: an outdated law tied our hands. There was some truth to those excuses, and state legislatures responded with laws that provide the regulators greater oversight authorities, including expanded examination powers. What rankles funeral directors is that the examinations are aimed at individual operators who had nothing to do with master program collapses.

With the preneed sale originating at the funeral home or cemetery, the on-site examination is a necessary component to effective oversight. However, state regulators struggle with how to conduct an effective preneed examination program. Limited budgets are also requiring the examination process to be efficient.

Illinois stands out from the other two states in that it had audit and reporting procedures in place before its crisis arose. Illinois funeral homes have given diverging descriptions of their audit experiences. Some reported having regular audits, while others report they had never been audited. To better understand the Illinois procedures, I requested a copy of the Comptroller’s examination guidelines. That request was declined with an explanation that such a disclosure may make it easier for funeral homes to circumvent the audit process.

The Illinois audit process failed both the industry and the consumer because the trust procedures contemplate depository funding and relied too heavily upon the tax cost basis of the preneed trust fund. The examination did not incorporate procedures regarding the qualifications of the depository/trustee, the investment of the funds or the fees charged to the funds. A recent conversation with an Illinois examiner suggests that the Comptroller continues to follow the old audit procedures despite their deficiencies.

In contrast, the staff for the Missouri State Board of Embalmers and Funeral Directors has been giving a lot of thought to how the on-site audit should be conducted. Prior to the collapse of National Prearranged Services, the State Board had minimal preneed reporting and examination powers. The examinations conducted this year are the first in 20 years, and recent regulation proposals provide a clue to what concerns the State Board staff have from those initial exams (isolated insurance policies, old contracts, etc).

While the State Board tabled the staff concerns for future discussion, those issues will continue to be reflected in the procedures followed by examiners (and by the preneed seller reports submitted to the State Board). For Missouri preneed sellers, the situation may only add to their frustration. First, there is the uncertainty of what to expect when the examination is conducted. And then, there are the issues raised by the examiner regarding practices that funeral directors may have been following for years.

There is not much that can be done about the frustration that stems from the evolving examination process. The preneed transaction is changing, and regulators will have to adapt their exam procedures accordingly. But the State Board will serve an important role in keeping the examination process focused on the crucial issues. That focus will be defined by the exchange that occurs between the staff and the Board over specific audit findings. These exchanges serve to educate the staff and examiners on the business of the death care industry, which should improve the efficiency of preneed oversight.

As other Midwest states initiate new preneed examination procedures, their regulators must find different ways to ‘learn the business’. Pursuing the wrong issues will only waste precious resources and alienate funeral homes and cemeteries.
 

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The funeral industry may grumble about the FTC’s Funeral Rule, but two disclosures required by that law play important roles in the preneed transaction. The general price list is often used by funeral homes as a tool for comparing prices with the competition. And when a prearranged funeral is performed, the statement of goods and services can be used to demonstrate the savings a family received by virtue of the preneed contract’s price protections.

Consumer advocates also utilize the general price list as a tool to educate the public on funeral costs. Periodic price surveys are facilitated by the Funeral Rule requirements. In an effort to expand its information base, the Kansas City chapter of the Funeral Consumer Alliance recently made a request of the metropolitan area’s cemeteries. However, a significant number of the cemeteries did not respond.

While some cemeteries may have been challenged to respond due to staffing issues or a lack of resources, there were non-respondents who were not comfortable making a public disclosure of what they charge. These types of disclosures are at The Bereaved Consumers Bill of Rights Act. Cemeteries are not subject to the Funeral Rule disclosure requirements, and the bill sponsored by Illinois Representative Bobby Rush would change that.

Representative Rush’s bill is a product of the Burr Oak cemetery tragedy, which had little to do with disclosures about the costs of cemetery property, merchandise and services. Regardless, the Burr Oak circumstances have been used to justify legislation for an expansion of the Funeral Rule to the cemetery industry. The cemetery industry has strongly opposed the legislation, citing that the penalties far outweigh the benefits to the consumers. Funeral trade groups have generally endorsed the bill. The funeral industry’s reasoning can be simply stated as what is good for the goose is good for the gander.

The cemetery industry’s objections to the expansion of the Funeral Rule have merit. Fines for technical violations are substantial, and could be devastating to smaller cemeteries. And, Federal enforcement of the Funeral Rule has been spotty at best.

But just as the KC branch of the Funeral Consumer Alliance has found out, gathering pricing information about cemeteries is difficult to do in the absence of the general price list requirement. The ICCFA posted model recommendations more than 13 years ago, but cemeteries have been slow to embrace them. Many cemeteries have also been slow to implement preneed sales programs. Economic survival dictates that cemeteries become more proactive regarding preneed. With that move will come the need for the disclosures required by the Funeral Rule.

The Kansas City chapter of the FCA will hold its annual Day of the Dead meeting to discuss the results of its cemetery price survey, and to press similar issues with this author. To download the KC FCA newsletter (and cemetery survey results) click here.
 

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The licenses required to sell or service preneed in Missouri must be renewed annually, with the deadline for filing the required paperwork falling on October 31st. Technically, these licenses expire on Halloween unless the State Board staff has renewed them by that date. But, it is human nature to procrastinate, and many licensees wait until the final days to file their paperwork. With 545 licensed providers, 331 licensed sellers and 179 licensed preneed agents, the deadline paperwork handled by the State Board staff is substantial.

Regulation proposals discussed at the State Board’s September meetings underscore the frustrations the staff have with the licensing deadlines and the paperwork submitted by licensees. The proposals would add pressure to licensees having renewal paperwork filed weeks (instead of days) prior to Halloween (so that the staff would have more time to review the paperwork before renewing the license).

The ‘rub’ for the State Board staff is that SB1 sets Halloween as both the deadline for filing paperwork and the expiration date of the licenses. The law fails to provide a window for the administrative review of paperwork. Before dismissing this as the staff’s problem, sellers should consider that SB1 also allows a consumer to void his/her preneed contract if the seller did not have a license when the contract was sold.

The problem for the staff is that a number of sellers are submitting renewal reports that have not properly completed. Sellers who only use one form of funding are omitting the schedules for the funding vehicles they do not use. The renewal forms also require a summary of all contracts sold during the reporting period. If the summary is left blank, the staff has no way of knowing whether the fee accompanying the renewal is correct.

For the most part, the current renewal report form is the same as last year’s. However, sellers that use joint account funding need to recognize the report has a new Section M that requires information about the preneed contracts sold prior to the current reporting period. If the seller waits until October 31st to file the renewal, and omits the Section M report in error, the State Board letter received in November will seem like a late Halloween trick.
 

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As discussed in prior posts, the Missouri preneed audit process begins with a notice to the preneed seller for the production of documents and data. After a review is made of the documents, data and the annual reports filed with the State Board, an on-site examination is scheduled with the seller. Most Missouri preneed sellers are unsure of what to expect. To an extent, Missouri has borrowed from the Texas Department of Banking examination manual in developing preneed audit procedures. However, Texas has the benefit of years of reporting and exams. Missouri is playing catch up, and the desk audit of the seller’s documents, data and annual reports are the State Board’s first in depth look at how funeral homes have structured their preneed programs.

SB1 made substantial changes to Missouri’s trusting requirements, and one purpose for the desk audit is to determine if the seller’s preneed contract form and trust agreement are compliant. But, the desk audit will also be used to match trustee reports to outstanding contracts, and determine whether the proper funding has been maintained.

For the State Board examiners, the first look at a seller’s records includes all outstanding preneed contracts. Missouri’s first preneed law was written in 1965, and some funeral homes have contracts dating back that far. Consequently, the initial desk audit could be a lengthy process for Missouri’s larger funeral operators.
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The examination of a Missouri preneed seller begins with a request that certain documents be submitted to the State Board within 3 weeks. The purpose for the document production is to allow the examiner to perform a desk audit of the seller’s operable documents before an on-site visit is made. From those documents the examiner will determine the funding methods used, the compliance of the preneed contract form (and other documents) with Chapter 436, possible funding deficiencies, and possible administration issues.

An important distinction that Missouri funeral homes must make is that the request is aimed at its preneed business written as a seller. The document request does not include preneed written on a third party seller’s preneed contract such as Missouri Funeral Trust, American Prearranged Services, National Prearranged Services and Funeral Security Plans.

The Board's document requests are as follows:

• A current statement from your state or federally chartered financial institution/s authorized to exercise trust powers in Missouri of any preneed trust account/s that you have identifying the payments, earnings, and distributions for each active preneed contract.

If the seller has trust funded preneed, the State Board is requesting a statement from the trustee that sets out aggregate payments, earnings and distributions for each active (outstanding) preneed contract. This requirement will prove problematic for most preneed sellers, particularly for their trusts established under the prior law. While many preneed trusts report income for purposes of Internal Revenue Section 685, they do not maintain records of the aggregate income and expense per consumer account. It is also unlikely the income distributions have been tracked by account.

With this request, the State Board is also putting the seller on notice that the trustee must be authorized to exercise trust powers within Missouri. Foreign chartered institutions have special requirements to satisfy this requirement.

• A current statement from any/all applicable insurance companies with which you have insurance- funded preneed contracts for each active preneed contract.

This seems fairly self explanatory. But, the funeral home needs to distinguish insurance assigned for a spend down for that insurance written concurrently with a prearrangement. Some insurance companies have taken an aggressive position on what constitutes a spend down, and the examiners will have the right to review both types of transactions.

• A current statement from your financial institution/s of preneed joint account/s for each active preneed contract.

If the funeral home used joint accounts, the State Board wants a copy of the current bank statements for the certificates of deposits and depository accounts. If funeral home receives individual statements, this production could require some work. Some banks provide a composite statement (that shows all the CDs). The funeral home may need to cross reference the account numbers to specific contracts.

• A copy of a ledger or computerized report showing all outstanding preneed contracts.

The State Board is looking for a comprehensive list of all outstanding preneed contracts. The current annual report only reflects those contracts sold during the last reporting period. It would probably be sufficient if the outstanding contracts were reported by funding (one report for trusts, one for insurance and one for joint accounts).

• Copies of agreements(s) with providers, agents, funeral director agents and if any contracts are funded by trust a copy of the trust agreement with the trustee.

The State Board is looking for all relevant agreements to the preneed seller program. SB1 was passed in response to National Prearranged Services, and its practice of representing a funeral home without an agreement. While SB1 does not require an agreement between a funeral home and funeral director agent, not all funeral director agents are employees of a funeral home. If a funeral home allows an independent agent to sell preneed on its behalf, an agreement exists. If that agreement has not been put in writing, and the agent violates Chapter 436, a swearing contest will ensue.

If the seller uses trust funding, the State Board is looking for the trust agreement and all contracts or agreements related to the administration of the trust. Many of the preneed programs offered to Missouri funeral homes involved the outsourcing of administration, and the examiners will need to know where to direct questions that may stem from that administration.

• A copy of the trust agreement with the financial institutions for any preneed trust.

Yes, this is a redundant request, and no, the seller doesn’t have to provide the trust agreement twice.

• A blank preneed contract currently used by you as a seller.

The examination will eventually review old contracts (and their compliance with the prior law), but the Board is concerned primarily with the current contract form’s compliance with SB1.
 

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The new era of preneed exams and audits got off to a slow start in Missouri, but now there are indications the process is picking up speed.   The first notices of preneed financial examinations went out to sellers last January, and some are now going through on-site examinations.  A second wave of examination notices has gone out, and the State Board has begun preparations for the first examination reports.       

While the examination process will continue to evolve, the process will likely involve the following stages:

• The notice and request for documents
• A desk audit of the seller's documents
• An on-site examination
• An exit interview
• An examination report and the seller response
• (If violations are found) a request for a corrective plan proposal

In our next blog posts, we look at each of the stages in more depth.

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The need for better preneed oversight is obvious, but regulators often lack resources and expertise. The state of Connecticut made headlines recently for the decision to make budget cuts by de-regulating the death care industry*. Connecticut funeral directors challenged the decision, and the state issued a ‘clarification’ and withdrew the plan. (That’s correct, the funeral industry challenged a plan that would have reduced their regulatory oversight.)

Connecticut still faces the issue of funding for death care oversight, an issue that every state faces. In researching last week’s post about the Maryland Office of Cemetery Oversight, we reviewed the meeting minutes posted to the Office website. Budget issues have been an on going concern, and the Office and the Advisory Council had discussed the per contract fee approach in one meeting, and then the problems with this approach in another meeting. The per contract fee amounts to a tax on the preneed transaction.

Missouri has one of the nation’s highest preneed taxes ($36, thanks to National Prearranged Services). But, as the Maryland regulators have experienced, it is not clear whether the preneed tax will be sufficient. Oversight has to be provided to even the smallest seller, and ten sales a year won’t pay the time required to make an on-site exam.

Missouri’s preneed oversight is provided by an industry board that is made up primarily of licensed funeral directors. You’ve heard the criticism of this arrangement before (the fox has been put in charge of the chicken coop), but service on the State Board of Embalmers and Funeral Directors is a time consuming obligation. These board members are looking for ways to improve the image of the industry, and credit is due to them when they come up with ideas that have merit. One such idea is the posting of disciplinary matters on the Board website so that consumers can perform their own due diligence on an operator before purchasing a preneed contract.

This is not a new concept. The Mississippi Secretary of State posts disciplinary orders on its website. For the most part, the postings are fully adjudicated matters that involve an agreed upon procedure for future conduct. But, the postings also provide some of the facts that gave rise to the disciplinary proceeding. Such postings help to inform not only consumers, but also funeral homes and cemeteries. 

*Reprinted with permission from the August 11, 2011 issue of the Memorial Business Journal. To subscribe please call 609-815-8145.

 

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The economy has preneed regulators concerned about depository accounts used for preneed funding.  A story reported in the Atlanta Journal-Constitution underscores the reason for this worry.  When a funeral home fails, consumers have little chance of defending the depository account from creditors' claims.  Insurance and trusts offer the consumer better protection when the creditors come knocking. 

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The “R” word is back again. We’re only three years removed from the housing bubble burst, but a sense of normalcy seemed to be returning to the death care industry. It wasn’t necessarily a return to the old ways, not with the increase in cremations and regulations. But, many operators were coming to grips with the changes that needed to be made. This past week’s events suggest the nation’s economy has entered another turbulent period that could last several years.

The debt-ceiling crisis, cuts to government spending, and foreign debt problems impacted US government bonds, foreign bond markets and the stock market. That’s bad news for insurance companies, preneed trusts and perpetual care trusts. Regardless of what type of funding a death care operator uses, the two-year economic forecast has to be concerning. The costs to servicing a guaranteed contract will likely outpace the funding growth.

Insurance companies will attempt to adjust through premium rate changes. But, can the consumer afford the premiums? As reported by the Wall Street Journal a year ago, consumers are finding they cannot afford the multiple pay policy, and if they have to cancel, the cash surrender value is a fraction of the amount paid.

We panned this article when published because it tried to characterize preneed as an investment, and for the elder attorney’s naïveté. However, the concluding recommendation has merit. A final expense trust provides both the consumer and death care operator a funding alternative that can meet their respective needs: affordability, flexibility, protections and higher cancellation refunds. But, it is not practical advice to tell the consumer to start up his/her own trust. Rather, this is an opportunity for death care operators to offer a product matched to the times.
 

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Not that close, even from the 30,000-foot view.

That’s our assessment of the Morningstar analysis of preneed and its impact on the death care industry. In “Dark Clouds for the Death-Care Industry”, a stock analyst attempted to explain the preneed transaction, and then provide an assessment of the impact of preneed on the profitability of the death care industry. Such attempts to generalize preneed are often misleading, particularly by an outsider looking in.

While the analyst raises a number of issues regarding preneed, only one can be described as generally accurate: there is a growing reliance on preneed sales. But then, operators in the smaller or rural communities may disagree because they do not face the competitive pressures that drive preneed sales. For the majority of the industry’s operators, competition has made preneed a necessity.

The article suggests that all preneed sales end up in trusts, and that the trust exposes the operator to investment risks. While this generalization has some merit, it completely ignores insurance funded preneed, and how those sales provide a background to assess the analyst’s preneed conclusions.

A majority of the states have preneed funeral laws that impose trusting requirements of 90% or more. The costs associated with a preneed program force larger operators in the 100% states to use insurance funding for the commission that will pay salesmen. The complaint currently heard from these operators is that the return on their insurance proceeds is not keeping pace with inflation.

The analyst states he would feel more comfortable if the industry turned to insurance companies for underwriting of the industry’s massive trust portfolios. Excuse me? The main problem with preneed trusts is that they are saddled with expenses, and are often ‘parked’ in fixed income investments. So, Wall Street’s solution to preneed would be to add a layer of expense through underwriting? Ignoring the state law issues, aren’t you suggesting to the operator that he should sacrifice the upside of his trust for the stability of a lower, more consistent return? How would that recommendation achieve the growth that you state is lacking for this industry?

The analyst also states that the industry must rely on preneed because of the lack of overall deaths in the marketplace. Perhaps the analyst meant to say there is too much competition for the current death rates in our communities. If so, then yes, preneed is becoming as important as heritage in maintaining (or growing) the operator’s market share. If the investment community believes preneed is bad for us, how would Wall Street propose funeral homes and cemeteries respond to competition in the market place?

Wall Street concerns over preneed are driven in part by misconceptions about the operator’s costs, and his exposures to trust funding liabilities. The analyst fails to make a distinction between the cost to perform a preneed contact and the prices listed on a general price list. The amount paid out of a trust when a preneed contract may not equal the current at need prices, but the trust proceeds do generally exceed the costs of the services and merchandise. Depending on the age of the contract, and the state’s trusting requirements, the older contracts may not be very ‘profitable’, but there is a profit, just not as profitable as the comparable at-need service.

The analyst also expresses concern the operator’s liability to fund the trust when the investment markets decline as they did in 2009. What state law requires that? Operators are not required to make ‘capital injections’ into their preneed trusts for investment declines. Such conditions may affect their authority to make income withdrawals, but not to require additional contributions.

Wall Street would prefer the death care industry to return to the day where at-need revenues constitute the base of operations. Most death care operators would share that desire, but most know better. Contrary to the analyst’s conclusion, operators are finding that it is the at-need service that is exposed to downturns in discretionary spending. Tight times make it easier for the consumer to choose cremation. If the preneed contract is paid in full, the family isn’t forced to come out of pocket to pay for the traditional service.

In conclusion, I have to concede that the analyst is somewhat correct about preneed exposing the operator to investment risks. Preneed has become a business reality, requiring many operators to make a decision between insurance or trust. Should the operator take the lower, but safer, rate of return of the insurance policy, or keep the upside of the trust (and its risks)?

Large funeral operators in 100% trusting states don’t have much choice but to use insurance.  For the funeral operator who wants growth and control over the direction of the preneed fund, then there is little choice but to assume the investment market risks that accompany the preneed trust. Cemeteries have no choice but to use the trust, and assume its investment risks. Cemetery preneed can be distinguished from that sold by funeral homes in that some merchandise (and services) is delivered prior to death, precluding the use of insurance.  

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Preneed scandals in Illinois, Missouri, Texas, and California have state regulators moving to implement new audit procedures. But with new laws passed in the wake of NPS and state master trust problems, the frequency and scope of the future audit could change dramatically.  It is no secret that the scope of the preneed audit in Missouri is work in progress. When asked how the audit was being revised for its licensees, Illinois regulators politely declined to provide their written guidelines. Regulators in Kansas and Nebraska are also evaluating their audit procedures. But, the legal battle being waged in California provides a glimpse of one regulator’s intent to change the scope of the preneed audit.

The Ninth and Tenth Causes of Actions from the California Attorney General’s lawsuit against the California Master Trust allege that defendants either failed to maintain, or to produce, the preneed records required by law and regulation. California Code of Regulations, title 16, Section 1267 sets out those records that must be maintained by the funeral home. The regulation dates back 30 years, and reflects a view of the preneed transaction that is no longer consistent with the view taken by the Attorney General, and with the direction of the audit and lawsuit.

In a nutshell, the regulation asks for records which are intended to confirm whether the preneed payments were deposited to trust. The underlying principal is that the preneed contract represents a sale that the funeral home will book to its GAAP financial records. The regulation defines the funeral home’s cash receipts journal and general ledger as preneed records. The requirements contemplate that the funeral home will book these sales and payments for compliance with income tax reporting. By requiring the financial books and records, the preneed auditor can then track a consumer payment from funeral home receipt to the preneed trust. While the funeral director might not fear the preneed regulator, he is not likely to hide the income from Uncle Sam.

However, the California litigation is not about money that didn’t make it to trust, it is about the administration of the trust assets. In attempting to investigate the administration of the trust, the preneed auditor went beyond what the regulation calls for. The best evidence of the expanding scope of the audit is the defendants' response letter to the Cemetery and Funeral Bureau audit findings. The response letter indicates that one funeral home was cited for failing to have the following records:

• All correspondence with the trust administrator
• Copies of contracts that provide services to the trust
• Records of administrative costs
• Records of administrative costs allocated among the trustee and its vendors
• The portfolio of trust investments

When questioned about its authority for the requests, the Bureau reply stated that the trustee failed to make available “complete financial records for all preneed contracts and arrangements”. This answer fails to clarify what trust and financial records the funeral home must maintain on its premises.

What seems to come through from the California litigation is that original approach to the audit, ensuring the funds made it to trust, and leaving trust oversight to the independent CPA and an opinion, failed the California consumer. But, could the Bureau have better protected the consumer if the financial records have been kept at the individual funeral homes? (No, not without additional guidelines on the management of master trusts and pooled accounts.) And even if such regulations existed, it would be expecting too much from the auditor whose duties entail visits to hundreds of the funeral homes.

While the field auditor is an important element of the preneed compliance program, the program has to include the administration of preneed trust. Does this mean the funeral director must maintain correspondence and records related to the trust’s administration? The best course of action would be to establish a file for all trust related documents and correspondence. With the increase of preneed portability and the sale of non-guaranteed contracts, the funeral director's reliance on the ‘guaranteed contract defense’ becomes more tenuous. In a limited sense, the funeral director is becoming a fund manager on behalf of the consumer.
 

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As reported previously in the blog, the State of Nebraska began to implement a preneed contract database in 2010 when master trusts were requested to provide individual contract data in an electronic format. The request was expanded to all preneed sellers in 2011.

Kansas Secretary of State sought legislation in 2010 for the authority to seek individual preneed data from its cemeteries selling preneed. While the KSOS initial effort fell short, a second effort passed the legislature a few weeks ago. Under this new bill, cemeteries will be required to trust preneed sales at 50% of the sales price and to report those sales (together with deposits and distributions) on a quarterly basis.

Illinois has now joined the preneed database club with an amendment made to SB0675. The bill will require preneed contracts to be entered into a database maintained by the Comptroller within 45days of the contract date.

As opposed to the paper report of individual contracts, the preneed database provides the regulator more flexibility in reviewing information and creating contract listings from which to begin audits and examinations at the funeral home or cemetery.
 

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The Missouri State Board of Embalmers and Funeral Directors staff has some new faces, and in contrast to most rookies, these newcomers are playing pivotal roles in developing examination procedures for the state’s preneed funeral sellers. The Division of Professional Registration chose personnel with prior auditing experience, but as these ‘rookies’ are learning, there is little in the way of guidelines for the examination of trust funded preneed. Missouri’s preneed heritage only makes their task more difficult.

With one of the nation’s more generous trusting requirements, Missouri is dominated by preneed trusts. Until SB1’s passage in 2009, the State Board lacked rulemaking authority to address the numerous gaps and ambiguities in Chapter 436. Chapter 436 also governed the sale of vaults and burial services, which brought cemeteries into the mix. Allow an industry to operate 25 years without examinations or rules and you get a hodge podge of seller programs, each operating differently from the next guy.

Like Forest Gump’s box of chocolates, the preneed examiner may experience a surprise with each seller he/she visits. While these surprises may not necessarily constitute violations of Chapter 436, they can be challenging when seeking a certain continuity from seller to seller. It is that continuity that will help define the examination procedures to use with the preneed trusts established prior to SB1.

As a consequence, Missouri’s preneed examination procedures remain a work in progress. The initial exams will probably take longer, with the examiners comparing notes and revising the draft procedures with each examination. For the time being, those procedures will focus on whether preneed sellers and providers are complying with new preneed contract and licensing requirements, and with the handling of that the preneed payments are being made to the proper funding agent. One of the procedures to be tested by the examiners will be a consumer letter.

As a part of the final stages of the preneed seller exam, the State Board staff will generate a consumer letter with information from the annual report filed by the seller. The letter will go to each consumer who is making payments on a contract, or who has lapsed in making payments. A sampling (5%) of the seller’s paid in full contracts will also receive the letter. The letter will set out the consumer’s contract number, the sales price and payment balance (as reported by the seller), and the request that the consumer contact the examiner only if the consumer’s records conflict with that data.

As reported by the blog in February, Illinois also has a consumer statement requirement, but it differs from Missouri in that the preneed fiduciary must send out the statement, and provide information about expenses and the trust ‘inventory’.

Funeral directors are fearful that such consumer notices will cause confusion, and lead consumers to believe the funeral home is in trouble. While problems may be encountered, the consumer notice is one of the few procedures available for detecting the small percentage of funeral directors who pocket the consumer’s payments. But if handled correctly, the statement could be used to help to maintain consumer confidence in the funeral home.
 

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Missouri’s preneed regulator, the State Board of Embalmers and Funeral Directors, will meet June 2nd to continue its discussion of agenda for the upcoming legislative session. Due to the lead time required to formulate legislation, the State Board is forced to begin discussions before its 2011 legislative agenda (SB325) even becomes law on August 28th. With the examination process having only begun this past January, the State Board does not even have the basis to evaluate crucial provisions of Senate Bill No. 1. Accordingly, the State Board faces decisions about what its legislative goals should be for the next year.

For the June 2nd meeting (and its prior May 18th meeting), the State Board staff went back to the various legislative proposals made during the summer of 2010 as a starting point. The temptation of Board may be to go through those proposals and evaluate each one on its merits. But the better approach would be to evaluate each proposal in terms of need and consistency with the legislative intent for SB1.

For example, page 9 of the June 2nd agenda includes changes intended to take preneed trusting to 100%. The proposal was discussed on May 18th, put up for a vote, and then withdrawn for further discussion on June 2nd. While it would be worthwhile to have a discussion on the merits of the proposal (including how 100% trusting would benefit both the consumer and the industry), the more important questions are whether the proposal is needed, and whether it is consistent with the legislative intent of SB1.
 

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For a brief period, the Illinois Comptroller posted a notice that sidestepped the inquiries made by funeral directors about the application of their Merrill Lynch settlements. The OIC website has since be revised.

One of the inquiries to the OIC may have involved whether the settlement funds could be applied to the litigation costs for pending lawsuits against Merrill Lynch. But for the litigation brought against Merrill Lynch, the funeral homes would not have received the settlements paid by the Department of Insurance. However, the settlement funds fall far short of the actual damages suffered by the funeral homes and consumers, and the argument may be that a portion of the funds could be used to continue the litigation.

Specifically, the Comptroller’s answered as follows:

It is the position of the OIC that we do not have the authority to instruct industry members on the proper disbursement of the funds.

In the following paragraph, the Comptroller warns:

During the review of future annual reports and audits, we will examine the method in which the funds are handled to assure that industry members acted in a good faith manner and in the best interest of consumers when determining the disposition of the funds.

While the litigation argument has merit, the Comptroller probably had concerns about the other uses funeral homes may have for the settlement funds. The notice may seem evasive to the industry, but it did not necessarily foreclose the application of funds to litigation that may benefit the consumer. But, funeral homes should pay heed to the warning that they will be held accountable for how settlement funds for active contracts are applied.
 

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Many state preneed regulators share the point of view that the payments made toward a preneed contract belong to the consumer until the prearranged funeral is provided. This perspective was adopted by the California Attorney General in its Eighth Cause of Action brought against the California Funeral Directors Association and its Master Trust. The AG criticizes the CFDA for investment decisions that are fairly representative of those taken by the industry as a whole.

Early on, the CMT relied upon bond funds that specialized in zero coupon government bonds. The AG points out that U.S. Treasury Bonds and similar bond funds outperformed the CMT at less risk and with lower fees.

When the bond market crashed in 2001, the CMT experienced substantial investment losses and changed investment course. The CMT began diversifying, and purchasing mortgaged back securities, foreign bonds and notes, corporate asset-backed securities and other types of securities. The AG criticizes these investments by stating “these types of investments are not insured bank accounts, are not bonds that are legal investments for commercial bank (sections 1001 et seq. of the Financial Code lists certain legal investments for commercial banks), are not government bonds, and do not comply with the Uniform Prudent Investor Act (as discussed below).”

The AG goes on to argue that the investment policies of the CMT should be set by the risk and return objectives of the preneed contract beneficiaries, and faults the defendants for having set investment policies based on their own needs.

Other states’ preneed regulators (and cemetery regulators) share the California AG’s point of view. It is common to hear a regulator characterize the preneed trust as a depository account or to express the belief the industry would be better off if preneed funding were left to the insurance companies. These regulators need to take the blinders off.

The CMT, like so many preneed trusts, went into tax exempt investments after 1988 because of Revenue Rul. 87-127. The Internal Revenue Service pushed for an income reporting method that proved impractical and burdensome. To compound the situation, the IRS applied the ruling retroactively to certain states. California was one of those states. Prior to the ruling, funeral homes had no reason to require the consumer’s social security number when selling a preneed contract. Consequently, many California trustees could not comply with the ruling with regard to existing contracts.

The ruling required grantor statements to be sent to consumers, and the consumers complained. So, funeral homes instructed their preneed fiduciaries to go into anything that didn’t require a grantor statement. While the CMT went to zero coupon bonds, the IFDA went into the poorly conceived key man insurance. Other trusts went into annuities. Various approaches were taken because the IRS could not provide reporting guidance once it changed the rules.

In stating that the preneed funds must be invested pursuant to the contract beneficiary’s objectives, the California AG has ignored the fact that a majority of these preneed contracts are probably guaranteed. Under that arrangement, the funeral home has assumed the investment risk. From a practical approach, how would the investment advisor determine the objectives of the thousands of preneed beneficiaries? In a prior post, this blog reported about an Illinois contract beneficiary’s complaint about the IFDA Master Trust. In contrast to the losses suffered by the member funeral homes, the beneficiary experienced a modest return on her non-guaranteed contract. Her complaint was that the return was not enough to keep up with rising funeral costs.

The California AG argument that the CMT must comply with the Prudent Investor Rule in a way that does not expose trust principal to risk is the equivalent to handcuffing both of the investment advisor’s hands behind his back.

Of the investment complaints made by the California AG, the one which would seem to merit the most attention would be the relationship between the former investment advisor and a CFDA board member. That CFDA board member also served as a trustee for one of the advisor’s funds, for which he received compensation. That relationship warrants an inquiry whether the relationship was disclosed and the compensation appropriate and reasonable.

The AG’s argument that the investment advisor must be independent from the seller is one shared by Missouri regulators. The Missouri regulators are quick to point to the abuses committed by NPS and its investment management firm. (See our post titled “The Zeal for Independence”). Those abuses were so bad that the Missouri legislature passed a provision prohibiting a relationship between the seller and the fund manager. This author thought the provision went too far. (See our post titled “Regulating Out of Context”). With the passage of SB 325, the Missouri Funeral Directors Association has convinced the Missouri legislature that it did go too far.

Regardless of whether the fund manager is a fiduciary employee or an independent investment advisor, that fund manager should appropriately look to the preneed seller for input about investment objectives. For the larger trust, the fiduciary and fund manager should adopt a written investment policy that, among other factors, considers the trust’s mix of guaranteed and non-guaranteed contracts. If the fund manager is an independent investment advisor, the relationship should be documented with an agreement that discloses all forms of compensation. Consistent with the SEC efforts to reform mutual funds, the disclosure should address any 12b-1 fees. The agreement with the fiduciary should also disclose all relationships the investment advisor has with the preneed seller.

To the extent the preneed contract is guaranteed, the regulator needs to recognize the seller’s economic interest in the trust’s performance. But, fiduciaries and sellers need to consider the growing number of non-guaranteed contracts and the possibility that the guaranteed contract may be serviced by a different funeral home. While the seller may have the prevailing economic interest, not all of the trust may be considered his for investment purposes.

 

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A breakdown in communications between the CFDA and the Cemetery and Funeral Bureau has resulted in the California Attorney General filing a lawsuit that can be appropriately described as vitriolic. The “California lawsuit” could provide some valuable ‘what to avoid” lessons for regulators in other states.

In an unusual move, the Bureau went “public” last year by raising a number of issues with administration of the California Master Trust. Some of those issues did warrant an explanation. One issue involves the actions taken by the CFDA subsidiary in response to the 2000 market crash. The subsidiary implemented a plan to stabilize the master trust value after the collapse of a bond fund. Another issue regards the administration fees charged the master trust subsequent to the collapse of the bond fund. A third issue regards the subsidiary’s policy to pay a portion of the administration fees to participating funeral homes.

The CFDA countered with arguments of how its actions were within California law. Those arguments have merit, and were covered by this blog in July 2010. (See California Master Trust: serious missteps, but not another IFDA.) The CFDA proposed that the issues be reviewed in the context of relevant facts, having the Bureau apply thirty year old laws and regulations to the CMT’s circumstances. Instead, the California Attorney General adopted a “quick kill” strategy that employs a two prong attack: involve the consumer and apply the law strictly.

In taking the controversy to the consumer, the California AG has been disingenuous when using such terms as “conspiracy”, “concocted”, and “kickbacks”. In doing so, the AG may end up galvanizing the CMT membership, and getting anything but a quick kill.

The AG’s legal arguments are also somewhat disingenuous. As the title suggests, this blog entry will focus on the AG’s call for a truly independent trustee. In future entries, we will look at some of the AG’s other legal arguments.

In the “First Cause of Action” of the petition, the AG makes the argument for how the CFDA’s administrative subsidiary has assumed unlawful control over the preneed funeral trust. Granted, the CFDA may have gone too far in assuming control over the trustee’s appointment of agents (and discounted the interests of consumers with non-guaranteed contracts), but the AG ignores the fact the master trust consists of thousands of preneed contracts that originates in hundreds of funeral homes. This fact makes the fiduciary dependent upon the funeral home in a number of ways.

The trustee needs preneed contract data for accounting (much in the same way the regulator’s auditor is dependent on the same records to perform his job). As with other states’ master trusts, the association performed a vital role in providing crucial contract administration. Contrary to the AG’s citation to the California probate code, these are administrative functions the corporate fiduciary must delegate. The trustee cannot account for the preneed contract as a depository account.

The trustee also needs input when setting investment policies. The AG would suggest that the preneed trustee cannot look to the funeral home. This ignores that the vast majority of the preneed contracts are guaranteed, where the funeral home has assumed the risk of investment. It also flies in the face of the numerous “No Action Letters” issued by the Securities Exchange Commission.

The manner in which the trustee prepares trust tax returns impacts both the funeral home and consumer. The most efficient approach (Federal Form 1041QFT) has a cost to the funeral home. Consequently, the preneed fiduciary will want the funeral home’s approval.

The ‘independent preneed trustee’ may seem to be a quick and easy answer to regulators, but only if the courts ignore the facts and realities of administering a preneed trust.
 

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Continuing the theme that effective preneed regulation requires the occasional update, the Missouri legislature is poised to pass the first ‘patch’ to SB1, the 2009 legislation that ‘re-wrote’ Chapter 436. Senate Bill No. 340 will make four noteworthy changes to Chapter 436.

Concerned that preneed sellers would use variable annuities to fund preneed contracts, Missouri’s insurance regulators sought to have SB1 limit the use of annuities to the single premium variety. This proved burdensome to funeral homes committed to insurance funded preneed. The single premium requirement denied the funeral home the use of variable pay annuities for consumers who either do not qualify for life insurance, or who cannot afford the premium of a life insurance policy. SB340 appropriately allows variable pay annuities to be used to fund preneed contracts so long as death benefits are never less than the premiums paid.

While SB1 preserved the use of joint account funded preneed, small operators encountered problems with banks and the Patriot Act. SB340 will allow POD accounts to be used in funding preneed contracts.

SB1 provided for retroactive application in certain respects. But, with regard to preneed trusts in existence prior to August 28, 2009, SB1 provided for historic law treatment with regard to income distributions to sellers and the use of income to pay trust expenses. Section 436.031 authorized the distribution of trust income to the seller provided the mark to market requirement was satisfied. The section also obligated the seller to pay trust expenses and taxes because of trust income withdrawals. SB340 will delete that provision, and it isn’t clear the intent for this change.

Section 436.031 of the prior law also allowed a preneed seller to designate an investment advisor, and in doing so, relieve the trustee of all asset management responsibilities. This provision was exploited by NPS, and was pivotal in conversion of millions of dollars of preneed trusts to worthless insurance. Seeking a completely independent trustee, SB1 imposed restrictions on who could serve as an investment advisor to the trust. While the NPS experience proved the need to keep the fiduciary responsible for asset management, SB1 went too far in driving a wedge between the asset manager and the seller. SB340 will create an exception to that restriction for the “external” investment advisor who satisfies Section 436.440.

 

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Microsoft’s early efforts to force regular program updates were a nightmare. Like a gremlin that visited at night, the update often changed default settings that you never completely understood in the first place. Sometimes the update would impact the compatibility of other critical programs. To avoid the hassle of these updates, I toggled off the Microsoft updates for several years. And then when a drive failed, dozens and dozens of MS patches and updates had to be downloaded and installed, costing me time and expense.

The preneed regulatory systems set up by various state legislatures in the 1980’s have begun to crash for the same reason: a failure to update. Preneed has changed since the days when bonds paid double digit returns and preneed programs were the fad. California was no different from most states where preneed opponents outnumbered preneed proponents. Legislative compromises favored the traditional operators who opposed preneed, and the resulting law was disjunctive and confusing.

As time passed, more and more California funeral homes began to offer preneed. In most cases, it started as an accommodation to the consumer who sought to put funds aside. Eventually, competition not only drove all funeral homes to offer some form of preneed, it also drove them to factor preneed into their business plan. The investment markets also became more complex.

But, the California funeral industry left the preneed law update toggled off, and instead, stretched the law’s ambiguities the best it could to “authorize” new business practices. And, the preneed regulators (first the State Board, and now the Bureau) often played the same game. The Bureau and the CFDA are now locked in a lawsuit (over an antiquated law) that will leave both sides bruised and defensive. The posture taken by the AG suggests the fight could be nasty. But the facts suggest, the State should look to make prospective changes.

NPS exploited the weaknesses of Missouri’s 1986 law, and that company’s collapse gave Missouri regulators the ammunition required to force a new preneed operating system on its funeral industry. The 2009 law has its flaws, and needs changes (other than those in SB340), but preneed life continues in Missouri. Missouri regulators would like to go back in time to change some of the prior law’s flaws, but the push to make retroactive changes has been measured.

In Illinois, the IFDA put together a master trust and an insurance program that pushed the envelope beyond the Comptroller’s tolerance. The Comptroller’s responded much in the same vein as the California regulators did. While entrenched in a lawsuit, the Comptroller pushed his legislative agenda through the legislature. But, Illinois got more of a preneed system patch than a new operating system. Eventually, Illinois is due for a significant preneed system upgrade.

Nebraska is another state that may be due for some form of a preneed update. With a reporting system based on tax cost basis, preneed regulators want to introduce market value into the computation for income distributions. The objective has merit, but the 1987 law can only be stretched so far.

Getting a preneed law that works for both operators and regulators will never be a “one and done” project. Occasional updates will be required.
 

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When news of the indictment of 6 National Prearranged Service officers was reported last November, many newspapers picked up the AP version that included a quote from the Internal Revenue Service criminal investigator. The fact is that the Federal investigation of NPS involves investigators from the IRS, the FBI and the U.S. Postal Inspection Service. An FBI press release regarding the NPS indictments includes comments from investigators with the three Federal agencies. To understand how NPS’ actions triggered the jurisdiction of the three agencies, a 2009 FBI press release concerning the indictment of Randall Sutton provides an explanation of the underlying facts.

The main thrust of the IRS investigation will be to determine whether the NPS officers committed income tax evasion with regard to what they individually received, or with regard to what the company received. The investigation will need to determine how the distributions from insurance, and from trusts, should have been reported by NPS. The investigation will also need to examine how NPS’ sister corporation, Lincoln Memorial Life, reported its income. And, the investigation will look at how the preneed trusts controlled by NPS reported their income.

Shortly after the Federal investigation of NPS was initiated, the Springfield Journal-Register reported that a Federal investigation of the Illinois Funeral Directors Association master trust had been initiated. As with NPS, Federal investigators will look closely at whether the reports mailed to funeral homes, and the statements mailed to consumers, were fraudulent, and thereby, violated mail fraud statutes. However, another line of investigation will be whether the master trust violated the Federal tax code.

What does the IRS’ role in these investigations mean to funeral homes and consumers? If these entities failed to accurately report income, the IRS (and state authorities) will view the unreported income as lost revenue to government. Preneed trust income must either be reported to the consumer or taxed by the trust. NPS trusts may have had annual tax liabilities in the tens of millions of dollars. No small potatoes considering the plight state coffers currently face.

Consequently, consumers and funeral homes may see taxing authorities become more aggressive in the enforcement of preneed income reporting requirements. With fewer agents due to budget constraints, the IRS may begin promoting its whistleblower program. If the situation reported this past weekend is an indicator of the future, non-compliant preneed companies may have more to fear from the disgruntled employee than being selected for a random audit by the IRS or state department of revenue.
 

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The 2010 calendar year proved a welcomed change for many trust funded preneed programs. The 2008 collapse of the home mortgage market triggered a melt down of bonds that lingered well into 2009. The press provided extensive coverage of how the situation impacted our 401k accounts. Stories about value declines of 25% to 33% were fairly common. But, most preneed trusts suffered a similar experience. Preneed fiduciaries were forced to examine fixed income portfolios for impaired assets, and some mortgage backed securities (long the staple of preneed trusts and endowed care trusts) had to be sold off.

In 2008 and 2009, many preneed trusts experienced capital losses that exceeded realized income. For the preneed trust reporting pursuant to a Federal Form 1041QFT, this black cloud had a silver lining: capital losses could be carried over to future years. With trusts seeing 2010 returns in the high single digits (and some double digit returns), the capital loss carry over provides fiduciaries an opportunity to reduce (or eliminate) the trust’s tax liability in 2010.

The manner in which a fiduciary applies the capital loss carry over (or CLCO) depends on how the 1041QFT was prepared in prior tax years. The QFT return contemplates individual trust accounts with a composite return, but IRS commentary suggests that a significant portion of QFT returns is prepared as a single, unified trust (see our August 9, 2008 post titled “The Section 685 QFT amendment: Supporting Soldiers’ Survivors”). With a composite return, the tax rate rarely exceeds 15%. With the unified trust, the tax rate will generally be 35% (when the trust income as a whole exceeds $11,200).

With the composite return, the CLCO is allocated among the individual accounts, and may be carried over in multiple years. With unified trust, the CLCO will be applied to the entire trust. In either case, the tax savings could be substantial.

Getting the 2010 return right may be more important than ever. As we will report in an upcoming post, the NPS collapse (and perhaps the IFDA/Merrill Lynch debacle) has caught the IRS’ attention. After twenty years of slumber, our tax regulator has reason to take a closer at how preneed is taxed.
 

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For most Illinois funeral homes, March 15th is the due date for the filing of their preneed data with the Comptroller’s office. For those funeral homes that bolted from the IFDA after the master trust melt down, this has been an extremely frustrating process. The majority of funeral homes must file on line, with supporting documentation to be mailed no later than March 16th. Those funeral home operators of Irish descent will have reason to hoist an extra brew come St. Patty’s day: the Comptroller’s office has ample reason to change the contract reporting requirements yet again.

The 2010 reporting forms were changed to reflect SB1682’s elimination of depository accounts. However, the annual reports are still premised on the old IFDA master trust structure that credited consumer accounts with an amount of fixed interest. For each consumer preneed contract the funeral home is required to report beginning principal and interest, additions of principal and interest, withdrawals of principal and interest, and ending totals of principal and interest. In essence, the annual report views each consumer account as a passbook saving account.

No need to beat a dead horse, but the IFDA master trust was wrestled away from the association because the Comptroller determined the trust could not sustain itself. Contracts were being credited with interest rates greater than the trust’s investment return.

In response to the situation, the IFDA selected Fiduciary Partners to succeed Merrill Lynch as the master trust fiduciary. The switch to Fiduciary Partners includes a needed change in the investment strategy of the IFDA master trust: diversification through pooled funds.

To determine whether the IFDA master trust (or score of master trusts spawned in the mass exodus) will be self sustaining, the Comptroller’s office will need to revamp its annual report to track such contract issues as sales price, deposits to trust, and market value allocations. In light of the IFDA’s past use of insurance vehicles, Illinois fiduciaries should anticipate providing detail of their trusts’ investments and transactions.

Other states’ preneed regulators are also drilling down to the individual contract with new reporting requirements. Most notably, Nebraska revised its 2010 annual report to include new disclosures regarding market values, with all preneed sellers to provide individual contract data in an Excel format. The data must also be backed up with trust asset listings and transaction reports. Missouri has also implemented individual contract reporting, and Kansas has legislation pending that will impose similar requirements on cemeteries that sell preneed.
 

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Maybe it’s a response to shrinking state budgets, or the fact that the tracking of preneed funds is becoming more effective, but state and local prosecutors are assuming an expanding role in the enforcement of preneed laws.

While a recent report released by the Missouri State Board of Embalmers and Funeral Directors reflects a drop in the number of preneed complaints that it handled in 2010 (44 complaints after a spike in 187 complaints in 2008 and 127 complaints in 2009), the Missouri Attorney General’s Office reports having handled 887 preneed complaints in 2010. One of those complaints ended with a former Butler, Missouri funeral operator being sentenced to seven years in prison.

As previously reported in this blog, the new Illinois Comptroller responded very quickly to a preneed complaint by referring a funeral home to the State Attorney’s office for prosecution. In 2009, the Kansas cemetery regulator worked with local prosecutors when a Hutchinson cemetery acknowledged that funds were missing from both a preneed trust and a permanent maintenance trust.

Here in the Midwest, a death care operator could go years without an audit. While some states required some form of preneed reporting, there was little evidence those reports were being reviewed. Consequently, the operator who may have had trouble making payroll had little fear of prosecution so long as the preneed contracts were being serviced. That is changing.

Illinois, Missouri, Kansas and Nebraska have implemented (or will implement) new reporting requirements (and in some cases, audits). If trusts are found to be deficient or empty, regulators seem to be more willing to turn the matter over to a prosecutor who has a vested interest in protecting voters with an empty preneed account.
 

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We don’t like to be reminded of our mortality. Cemetery operators face this issue with many marker and monument sales. An illness may lead a husband and wife to begin making plans, which often includes the purchase of a grave space and a marker. But, it is difficult for many individuals to view a marker complete except for a date of death. Consequently, it is common for the couple to defer delivery of the marker until some future date. Unfortunately, some cemeteries (or monument dealers) go out of business, or change ownership, and the marker goes undelivered.

Until the law changed in Missouri in 2010, cemeteries were required to either deliver the marker within a reasonable time, or place 110% of the wholesale cost of the marker in a segregated account. The Missouri law now requires cemeteries to trust or escrow 80% of the marker’s purchase price when delivery is deferred. The new law presents two dilemmas for the cemetery.

In the situation where the marker is to be paid with installments, the cemetery will often defer delivery until the purchase price is paid in full (or at least until the cost of the marker has been received). Many consumers need the flexibility of installment payments to meet the costs of the marker. However, the cemetery has little recourse if the family ceases to make payments, except to defer delivery of the marker. Under the new Missouri law, cemeteries will be required to deposit 80% of those payments to trust or escrow, even if the contract only involves a 12-month installment period, and a prompt delivery on the last payment. This will add another layer of expense to the marker sale.

For the consumer who does not want to see his/her name on the marker, the cemetery also has the dilemma of rising costs. The costs of granite and bronze have risen dramatically over recent years, and show no signs of leveling off. With a marker, the cemetery has a product that it may be willing and able to delivery, but may be forced to defer, and in doing so, is also forced to watch the profit of the transaction being eroded over time.

Consumers who need the flexibility of installment payments should not be surprised if cemeteries pass on the additional costs imposed by Missouri’s new law. Similarly, consumers who don’t want to see their name on the marker (for which they have already paid) may also be required to bear additional expenses when delivery is deferred.
 

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If their preneed contract is trust funded, Illinois consumers should soon be receiving statements from the bank or trust company that administers their account. These statements are one of the new requirements imposed by SB1682. The contents of the statements are governed by Section 2.h of the Funeral or Burial Funds Act.

The Comptroller’s Office sought the consumer statement in part to require accountability for the fees and expenses being charged by the IFDA. The Comptroller has brought legal proceedings to force the Association to refund a portion of the fees charged to the master trust. The California Master Trust faces similar complaints from the Cemetery and Funeral Bureau.

One allegation common to both master trusts was the fact the fees being charged were based on a ‘value’ other than the trust’s market value. The regulators have also challenged the reasonableness of the fees.

Another emerging reform issue that could impact this new Illinois disclosure requirement is whether the fiduciary (or its affiliates) receives a 12b-1 fee.

Consequently, Illinois preneed fiduciaries have cause for being cautious when reporting how much the preneed trust arrangement is costing the consumer (and the funeral home).
 

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It is a bit of déjà vu for Kansas cemeteries. Legislation to increase preneed trusting and to require monthly reporting was introduced in the Kansas House. But HB 2240 will look familiar to those cemetery corporations that participated in 2009 and 2010 cemetery legislative meetings conducted by the Kansas Secretary of State.

As previously reported on this blog, the Kansas Secretary of State is seeking monthly reporting so that troubled cemeteries can be identified sooner. But, even the largest cemetery corporations claim that such reporting requirements would be burdensome.

The Kansas cemetery regulator is motivated by the experience of recent cemetery failures, and the need to impose requirements intended to keep the cemetery out of receivership, or as a ward of the state. As the law currently stands, regulators have few options until the cemetery fails (i.e., is unable to honor its preneed obligations).
 

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The start of Missouri’s new era of preneed oversight began when document requests were mailed to sellers on January 3rd. Sellers were requested to provide the following documents by January 28th:

· A current statement from your state or federally chartered financial institution’s authorized to exercise trust powers in Missouri of any preneed trust accounts that you have identifying the payments, earnings, and disbursements for each active preneed contract.

· A current statement from any/all applicable insurance companies with which you have insurance-funded preneed contracts for each active preneed contract.

· A current statement from your financial institution/s of preneed joint accounts for each active preneed contract.

· A copy of a ledger or computerized report showing all outstanding preneed contracts.

· Copies of agreement(s) with providers, agents, funeral director agents and if any contracts are funded by trust a copy of the trust agreement with the trustee.

· A copy of the trust agreement with financial institution for any preneed trust.

· A blank preneed contract currently used by you as a seller. 

If a seller established separate trusts for “Pre88” contracts, “Post88” contracts and “SB1” contracts, all trust agreements should be provided in response to the request. If the trustee has contracted for services (whether it be with the seller or with a third party), copies of the service agreements should be included. Sellers should have revised their preneed contracts since the passage of SB1, and so samples of relevant preneed contract forms should be provided.

From the trustee, the financial examiners will expect a report of the trust assets and a transaction report. The asset listing will be used to determine the trust’s compliance with the prudent investor rule, and the transaction report will be used to determine compliance with deposit requirements, distribution documentation and expenses charged to the trust.

Sellers should also anticipate that the financial examiners may request additional documents or reports before scheduling the on-site exam.
 

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This blog commented a few weeks ago on Dan Hynes’ failure to follow through on his own legislation. Since that post, the new Comptroller revised the Annual Report to eliminate references to self-trusted funds. However, funeral homes that transferred out of the IFDA master trust will still find the report difficult to complete.

The Comptroller’s Annual Report includes a schedule called the Annual Statement of Funeral or Burial Trust Funds, which requires the trust fund to be accounted for as though it were a depository account. The schedule seeks contributions, interest and withdrawals. The schedule doesn’t contemplate the losses suffered by the trust when Merrill Lynch liquidated the fund’s insurance investments.

For transferred accounts, the IFDA made those entries to the schedule required to ‘zero out’ the account. The ‘withdrawals’ reported by the IFDA will not reconcile to what the successor trustees received.

Ms. Topinka’s staff will find audit trail from Merrill Lynch to the new fiduciaries difficult to follow when relying upon the Annual Reports due March 15th.
 

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Many Illinois funeral homes were surprised when they opened their mail this past week. The Illinois Department of Insurance wrote to each funeral home that was determined to have a claim in the $18,000,000 Fund established by Merrill Lynch for IFDA master trust participants. The letter included a check and a spreadsheet allocating the check amount by individual consumer contracts.

Each funeral home will need to review the spreadsheet and identify those contracts that were serviced or terminated, and those contracts that remain active.

The funeral home will be entitled to keep the amounts allocated to guaranteed contracts that have been serviced according to the terms of the contract. If the goods and services were changed from what was described in the contract, the funeral home may owe the consumer a refund.

For non-guaranteed contracts that were serviced, the funeral home must compare the credit provided the family to the total amounts received for the contract. The funeral home will have to add the ML funds to the amount received from trust when the contract was serviced. If the credit given the consumer on the contract is less than the sum of the trust distribution and the ML funds, a refund is due the consumer.

If the preneed contract was terminated, the funeral home will need to review the contract and the amount originally refunded. In most cases, the settlement amount will be owed to the consumer.

For the active preneed contracts described on the spreadsheet, the funeral home will be obligated to apply the ML funds to the trust (or insurance) that funds the contract. Funeral homes must anticipate that the Comptroller’s Office will hold them accountable for these funds. (Funeral homes tempted to retain the entire settlement check should see the preceding blog entry.)

If the funeral home is entitled to a portion of the ML fund check, the check could be deposited to an operating account. The funeral home should then promptly write a check to the trust for the active contracts. If all of the contracts on the spreadsheet are active, the funeral home may want to endorse the check over to the trustee. The trustee will need a copy of the spreadsheet for purposes of crediting the accounts with the proper amounts.
 

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Missouri cemeteries received a brief questionnaire last week from their primary regulator. The Office of Endowed Care Cemeteries (the OECC) has responsibility for enforcement of Chapter 214, the Missouri law that governs endowed care requirements and preneed sold by licensed cemeteries. The OECC would seem to be sizing up cemeteries as candidates for Chapter 214 preneed audits. If a cemetery is selling preneed pursuant to Chapters 333 and 436, the OECC can cross the cemetery off its list. But the likelihood is that most cemeteries selling preneed have opted away from Chapter 436.

What may not be apparent to consumers is the fact that many Missouri cemeteries claim exemption from Chapter 214 endowed care licensing requirements. Some cemeteries site exemption from these license requirements based on religious affiliations, or because they restrict grave space sales to family or association members. These ‘exempt’ cemeteries face new regulation requirements if they sell merchandise and services that would be deemed “preneed” by Chapter 436 (and the State Board of Embalmers and Funeral Directors).

Consumers can conduct their own survey of a cemetery offering to sell burial services, monuments, urns and vaults before there is a death.

If the consumer is purchasing a monument or marker, and is making a single payment, ask whether the contract complies with Section 214.385 and provides for prompt delivery.

If the purchase of the monument or marker is being made with installments, with delivery deferred to the future, ask the cemetery for documentation regarding the trust or escrow account used for the payments. The cemetery will have to either comply with Section 214.387 of Chapter 214 or Section 436.435 Chapter 436.

If the cemetery is offering to sell burial services or vaults prior to a death, a portion of the consumer payments should be deposited to either a 214.387 trust or a 436.435 trust. If the cemetery claims to be exempt, or can’t answer the question, the consumer has reason to be concerned. Such concerns should be addressed to either the OECC or the State Board of Embalmers and Funeral Directors.

Finally, ask the cemetery about their endowed care license. If it does not have a Chapter 214 license, ask to see its Chapter 333 preneed seller license. If the cemetery is not licensed as an endowed care cemetery, it has no option but to be licensed as a preneed seller under Chapter 333.
 

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The ‘deadline’ for Missouri preneed sellers to ‘voluntarily’ report their pre-SB1 trust funded sales is a mere two weeks away. Again, this is a voluntary report. As such, missing the ‘deadline’ or failing to use the Board’s form carries no penalty to the preneed seller. So, why file?

The reason expressed by one State Board member was that the report would give preneed sellers the opportunity to demonstrate their trust was appropriately funded. Funeral directors active before the 2009 Missouri Legislature advised their legislators that the actions of NPS were not reflective of the industry as a whole. Legislators were informed that the vast majority of funeral homes put the consumers’ funds in the bank.

Missouri preneed sellers have three funding options: joint accounts, trusts and insurance. The issue of whether joint accounts are properly funded was addressed with the first provider renewal reporting filed this past October 31st. With insurance premiums posted to an insurance carrier, the Board decided trust funding would be their second priority.

The voluntary trust report is the opportunity for those sellers to put their money where their mouth is. Granted, the financial examinations proposed by the Division are far more intrusive than what had been discussed. But, the failure to back up the talk to the legislature will ring hollow in the face of the Board’s initial efforts to back up the industry’s representations.

Individually, funeral homes need to approach the voluntary reporting as another step in organizing their records in a manner to expedite the eventual financial exam. The goal is to get the exam over with a minimum of disruption and problems.

While many sellers are professing to be ‘as clean as a whistle’, most sellers will have issues. In the absence of regular oversight and guidance, funeral directors were left to interpret the law on their own. Mistakes were made, and the State Board would rather help correct those mistakes than pursue disciplinary actions that clog the administrative hearings docket. Accordingly, sellers could use the voluntary trust report to identify any issues they may have, and to outline their own corrective plan. Be a problem solver.

For those sellers who decide to make the Board examiners earn their keep, the expense of oversight will be pushed higher. The $36 per contract fee will prove inadequate, and the discussion will turn to increased fees. If the data should prove that a disproportionate amount of examination time was spent on small sellers who made no effort to comply, the larger preneed sellers will force the cost of the system to be more equitable. Under Illinois law, the preneed regulator has the authority to tag such a seller with a $20,000 audit fee. That represents 555 preneed contract fees that must be borne by the seller, not the trust or the preneed consumers.
 

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While the Comptroller succeeded in getting SB1682 passed, and into law this past February, the office hasn’t revised its annual preneed reporting form to reflect the law’s changes. The report contemplates depository accounts and self-trusted accounts, which were eliminated by SB1682.

Funeral directors, accustom to the IFDA’s assistance, may also find the trust report section confusing. The annual trust statement requests a break-down of trust funds by principal and interest. With diversified portfolios, the report would make more sense if it sought deposit balances, income and account values.

With transition at the Comptroller’s office, funeral homes will be forced to muddle through the upcoming report. The Comptroller’s office will need to be lenient with funeral homes attempting to comply. Eventually, the Comptroller’s office needs to step back from the old forms and procedures, and seek input on how to revise the annual report for easier compliance by the Illinois industry.
 

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Triggered by the NPS collapse, preneed reform rolled out of the Missouri legislature like a tsunami. When the funeral industry was slow to organize and respond to the situation, legislators worked with state officials to imposed sweeping changes. While SB1 does reflect input provided to the State Board by the industry, the law has flaws and omissions that need to be addressed. It will take time to determine how best to revise SB1, but for the current legislative session, I have a short Christmas wish list:

• A continuing education requirement – as a profession, funeral directors have an obligation to stay abreast of new issues and changes. Aside from preneed reform, the industry is in transition in many aspects. Few professionals like forced educational requirements, but the time has come for the Missouri funeral industry.
• Section 208.010.4 – no one can fault the local MO Healthnet worker who interprets this section to require an assistance applicant to purchase a Chapter 436 preneed contract. This law needs to be revised to clarify that other acceptable forms of final expense funds may be excluded for asset testing.

Merry Christmas!
 

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When funeral arrangements are made subsequent to the death of a family member, the meeting with a funeral director can be very emotional. Addressing the paperwork required by law often adds to the stress of the arrangement meeting. Sensitive to the individual needs of the family, funeral directors attempt to balance legal requirements with the emotional state of the individual who controls the deceased’s disposition.

The funeral director’s arrangement paperwork is defined principally by the Federal Trade Commission’s Funeral Rule. The Funeral Rule requires that the goods and services selected at the conclusion of the meeting be itemized with costs. The intent is then to allow the individual to evaluate the selections so that he/she can make any desired changes.

Funeral homes must also comply with the Funeral Rule when selling funeral arrangements on a preneed basis. For guaranteed contracts, this would mean that an itemization statement may be incorporated by the preneed contract. To cut down on the paperwork prepared at the time of death, a funeral director may be tempted to resort to the statement of goods and services used for the preneed contract. While this practice is not prohibited by the Funeral Rule, several factual circumstances would make the practice a violation of the Rule.

The FTC website includes “Recent Funeral Rule Opinions”. The opinions include explanations about various fact situations that impact how the statement of goods and services must be prepared. For example, if the preneed contract includes cash advance funds, the funeral director must consider whether the original statement’s descriptions are still accurate. If the family changes any of the original selections (for example, a different casket is chosen), a new statement must be prepared. If the original statement includes a generic description of a casket, it may not comply with the Funeral Rule.

Using the preneed statement may seem a convenience in saving time and minimizing the stress of the arrangement meeting, but the better business practice would be to prepare a new statement of goods and services. The new statement of goods and services also serves to document the funeral home’s compliance with the terms of the preneed contract. With preneed audits looming in various states, funeral directors may regret the time they attempted to save in the arrangement meeting.

Depending upon Congress, theBereaved Consumer’s Bill of Rights Act of 2009 may impose the same Funeral Rule on cemeteries.
 

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The Missouri State Board of Embalmers and Funeral Directors will take another step on December 7th towards the process of defining the examination process for preneed funeral contracts. True to mantra that has been repeated over the past several months: this is a work in progress that will evolve as more is learned.

The agenda for the December 7th meeting includes an attachment titled “Financial Examination Process – FAQ”. For the most part, the FAQ is rehash of what discussed at the Board’s October meeting. The FAQ sets out in general terms the steps that will be taken in an examination.

One issue that is not clear from the FAQ is whether the examination will review preneed contract forms for compliance with applicable law. If so, the seller’s contract forms should be included in the Paragraph 2a review request. Including the contract review as a part of the prep work for the on-site exam should cut down on the time spent on the seller’s premises.

Paragraph 2f should prove a crucial step in the process of resolving issues before they reach the Board. If the staff and examiners merely write up the issues and defer all decisions to the State Board, the Board will need to schedule more meetings.

Finally, the FAQ does not offer much with regard to the review of serviced contracts. While the staff’s proposal to review all outstanding preneed contracts drew the most comments, the serviced contract review could prove more instrumental to disclosing compliance errors or fraud.
 

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In a move to remain autonomous from the funeral industry and its oversight, the Missouri cemetery industry met with its regulator during the summer of 2008 to discuss reform legislation. Disagreements precluded effective legislation from being passed in 2009, but extensive changes was passed in 2010, and became effective on August 28, 2010. Now, the Missouri cemetery regulator has the task of implementing the law, and notifying cemetery operators and trustees of the new requirements.

Missouri’s Cemetery Endowed Care Trust Law (Sections 214.270 et seq) is administered by the Office of Endowed Care Cemeteries. A brief summary of the new law’s requirements can be found on the OECC’s website.

The new law makes substantial changes to perpetual care trusts (Section 214.330), sales documents (Section 214.282) and the preneed merchandise sales (Section 214.387).
Some perpetual care trusts define capital gains as income.

The new law incorporates the uniform principal and income act, precluding capital gains from being treated as income. This change is being imposed retroactively to existing trusts, thus forcing many cemeteries to amend their trust agreements. But, the new law does authorize fixed distributions that can exceed the trust’s income.

The new law also imposes the following requirements on perpetual care trusts:

A. Trust records must be made accessible to OECC examiners.
B. Trust instruments must be filed for approval.
C. Sales documents for interment rights and merchandise must comply with the Law, or the contract can be voided with interest refundable to the consumer.
D. The OECC can order the trustee to suspend your PC distributions.
E. PC deposits must be made on a monthly basis (instead of semi-annually).
F. The PC requirements have been raised for certain interment rights.

With regard to preneed, cemeteries must start from scratch. The prior law provided a low trusting requirement for services (opening and closings), and a segregated account requirement for marker and monument sales. To avoid the funeral licensing and trusting requirements of SB1, Missouri cemeteries must now comply with RSMo. Section 214.387. (To read a prior post on the new trusting requirement click here.)

Section 214.387 will require a cemetery to establish either an escrow account or a new trust, and comply with the following:

A. Escrow agents must be independent of the cemetery.
B. Escrow agreements and trust agreements must be filed with the OECC for approval.
C. Twenty percent of consumer payments may be retained but all subsequent payments must be deposited to a trust or an escrow account.
D. If a trust is used, all income must remain in the trust.
E. Deposits must be made within 60 days of receipt by the cemetery.
F. Preneed reporting to the OECC will begin in 2011.
G. New sales contract forms are required.

Banks that serve as a cemetery trustee will soon be receiving a letter advising of the new requirements. Missouri cemeteries will have more than New Year's resolutions to prepare for 2011.

 

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Missouri is one of the few states that does not impose a continuing education requirement for funeral directors. Where continuing education is required, the state funeral director association typically sponsors programs that satisfy the CE requirements, and provides revenues needed to supplement the association’s budget needs.

The passage of SB1 has provided the Missouri Funeral Directors and Embalmers Association with an opportunity to reach out to members (and non-members) with classes about the new law’s requirements. However, the MFDEA faces challenges in reaching the Missouri industry: attendance is not mandatory, the economy is down, funeral directors are taking a wait and see approach, and the interpretation of the law’s requirements by the Board/staff is muddled.

Since the law’s passage in August 2009, Board members and staff have expressed frustration with the industry. Funeral directors did not attend legislative hearings or Board meetings in the numbers that were anticipated. Response to the new licensing requirements has been slow, and accompanied by complaints.

The past two years have been demanding and time consuming for the Board and its staff. Those two years have been marked by trial and err processes, some of which have succeeded and some of which have been jettisoned. For an industry that rarely attends a Board meeting, the result has been confusing.

The proposed examination procedures discussed at the State Board’s October 27th meeting include controversial provisions that will likely change before the Board’s meetings in December. Reviewing every outstanding preneed contract of every seller would be time consuming and excessive. Under certain circumstances, such a procedure may be warranted. If a seller cannot provide indicia of what his outstanding preneed liability is, then the Board has no recourse but to look for every contract.

However, there will be an on site examination of every seller. And, there will be a review of at least a sampling of the seller’s contracts. The exam will also involve a review of the performed contracts. At the conclusion of the review, the examiner will conduct an exit interview to advise the seller of the findings. These minimum procedures will provide the Board and the staff an opportunity to educate each seller regarding issues on non-compliance. But, the next steps of the examination process will provide sellers an opportunity to educate the Board and its staff.

The examination procedures represent the best efforts of the staff, with input from the Board and other states’ preneed regulators. Preneed is not only unique from state to state, but often from seller to seller. And, there are Missouri funeral homes that will argue the current Board membership is not a fair representation of preneed sellers.

So, after the exit interview is conducted, the examiner will return to the Board offices to prepare a report. That report will be sent to the seller to so that it may provide comments, rebuttal and proposed corrections. Then the examiner and staff will have to opportunity to revise the report that is filed with the State Board. Then the Board will decide what actions should be taken. If the Board/staff and the seller are in disagreement, a hearing will follow.

The rebuttal report and Board hearing will provide sellers the crucial opportunity to educate the staff and the Board about practices and procedures that were not adequately addressed in the Chapter 436 hearings, or subsequent Board meetings. Pressures to pass a law, and then implement that law, have resulted in the Board (and staff) pushing aside issues. One on one with the Board, sellers will have the opportunity to slow the process down and address SB1 and how it’s being interpreted and applied. For staff that has only dealt with problem programs, or Board members familiar with their approach to preneed, the rebuttal report and hearing will continue Missouri’s preneed educational process.
 

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The earliest form of preneed consisted of a depository account at the local bank. Often, the paperwork included a statement of goods and services describing the individual’s preferences. The account was set up so that the funeral director could access the account upon the consumer’s death. The statement of goods and services would then be followed for the funeral. This arrangement was convenient to both the consumer and the funeral director. But, a recent news report out of Louisiana serves as a reminder of how the depository account has been too convenient, forcing states to take it away.

As preneed proliferated, state legislatures imposed safeguards to protect the funds paid by consumers. With the exception of New Mexico, all states now have trusting requirements. When those trusting requirements were initially imposed, a few states made exceptions to allow small funeral homes to continue to use the depository account. Abuses now threaten to eliminate the depository account as a form of preneed funding.

Illinois was the most recent to eliminate the depository account. In response to IFDA abuses, SB1682 now requires Illinois funeral homes to move their depository accounts to a corporate fiduciary and to revise their preneed contracts. Some Illinois funeral directors are painfully learning that the new law precludes them from using their local bank and familiar contract forms.

Missouri’s 2009 law preserved the depository account, but with substantial reporting requirements. Funeral homes dependent upon the depository account were required to report those contracts this past October 31st. Those reports will be used for on-site exams to begin in 2011. The future of depository accounts in Missouri will depend on how well funeral directors have complied with both the old and new requirements.

As discussed in a prior post, funeral directors who have been forced from depository accounts, or who must meet new requirements, need to seek legal assistance when revising their preneed contract form. The old practice of preparing a statement of goods and services is not enough for compliance with the new (and most old) preneed laws.
 

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The Missouri State Board of Embalmers and Funeral Directors has released its proposed preneed examination procedures. The release comes just 24 hours before the Board’s October 27th meeting, and so few funeral directors will be prepared to ask questions.

The proposal contemplates different procedures for ‘compliant sellers’ and ‘non-compliant sellers’. With most of the industry concerned about some issue of compliance, the proposal begs the question how the determination of non-compliance is made. The timing of the release and the October 31st renewal deadline suggest that the failure to timely file a properly prepared seller’s renewal may be the easiest way to fall into the non-compliant stack.

The October 27th meeting only allows an hour of discussion of the proposal, so the industry will have to anticipate the time for questions and discussion will occur at the Board’s December meetings.
 

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With the exception of a few states, each form of preneed funding has its own statutory requirements. Consequently, different contract forms are required for each method of preneed funding. So, what does this mean for the consumer worried about the safety of funds paid to the funeral home or cemetery.

Among the pecking order of contract forms, insurance funded contracts generally tend to be among the more compliant forms. The larger preneed carriers understand that if they are to win the funeral home’s business, the carrier must be able to provide the funeral home with the preneed contract form. When there is a problem with an insurance funded contract, often it is because the agent has chosen the wrong form. For example, the recent law change in Illinois requires new disclosures to be made in the contract form. If the agent pulls an old form, the contract is in violation of SB1682.

In terms of compliance, the trust-funded contract may place a distant second depending on who sponsors the trust (and whether the consumer’s state requires the filing of the preneed contract form). While the national companies (and some state associations) are diligent about having their contracts reviewed for compliance, that has not been the case for many independently owned funeral homes. While state associations are due credit for bringing a higher level of compliance to their state’s contract form, some associations (such as the contract forms used by the IFDA) set a very low bar.

The most suspect of the funding methods contracts is the depository (or self administered) account. With this funding method, the preneed seller is going solo without the assistance of an insurance company, the state association, or even a fiduciary. All too often, the operator assumes a contract is a contract, and ‘borrows’ a contract form from another funding method. Or worse yet, the funeral home uses the FTC at-need goods and services form as the preneed contract.

To prepare for a regulatory examination, sellers need to confirm they are using the correct (and current) contract form. Within each funding folder, the seller should establish a current contract form folder and a historic contract form folder. Similarly, the operator will want to maintain a current GPL and Outer Burial Container price list and a historic GPL and OBC price list folder (going back indefinitely).

While many consumers tend to purchase preneed based on personal trust earned by the funeral director, contract form compliance demonstrates that funeral director’s understanding of the preneed law. Preneed contract form compliance is also the consumer’s protection should the trusted funeral director ever be hit by a bus. The next owner of the funeral home will be bound by the terms of those preneed contracts, not necessarily the oral assurances of his predecessor.
 

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For the past several years, most preneed sellers were more likely to have been audited by the IRS than their state funeral or cemetery regulator. That will likely change in the next year or two for operators in a Midwest state.

The common response to an IRS audit would be to throw the relevant records into a box the weekend prior to the scheduled trip to the examiner’s office. But since the point of sale for preneed is at the funeral home, most states begin the examination process at the funeral home. In some states, the historical approach was to initiate the exam with little or no advance warning. Under such circumstances, it would behoove the preneed seller to organize and maintain his preneed records so as to expedite the examination.

While the duty to prove compliance is upon the licensee, few state death care regulators have issued any guidance regarding preneed record requirements. One challenge to providing such guidance is that a different set of rules is required for each method of preneed funding. Generally speaking, cemeteries are confined to trust funding because deliveries are made prior to death (thus eliminating insurance for much of what the cemetery sells). However, funeral homes often use both trust and insurance, and often multiple insurance companies and multiple trusts (Pre-88, Post-88, New Law, Old Law, my trust, state association trust, etc). And then some states also allow for depository accounts.

Sellers should set up different ‘boxes’ (or file drawers) for each method of funding. If the seller has offered insurance, trust and depository accounts, then plan on three drawers of documents. And if the seller has used Forethought, Homesteaders and NGL, three dividers will be needed for the insurance drawer. Similarly, the trust-funded drawer should have a Pre-88 folder, a Post-88 folder, and a new law folder. A folder for each bank used to fund a preneed contract should divide the depository drawer.

For the funeral home that approached the different sources of funding as diversification, this benefit comes at the cost of time to organize and maintain the necessary paperwork. Those operators that take the time to prepare and organize their records will minimize the examination’s disruption to their business, and the potential for citations for non-compliance.

In upcoming posts, the content of those folders will be addressed.

 

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It seems paradoxical to see preneed regulators ramping up audit programs while state budgets are being slashed to the bone. Yet, several I-70 corridor states will soon implement new preneed audit programs.

Missouri’s preneed funeral audits will be funded out of a combination of license fees and preneed contract fees. Missouri’s new cemetery law did not provide for any additional fees to offset the expense of a new reporting system and audits, and so, one most anticipate the state will look to recover from its expenses from non-compliant cemeteries.

Colorado had a modest, but significant, law change: the preneed regulator was granted authority to assess fees against preneed sellers to fund examinations. With a source for funding, new audit procedures have been submitted for approval.

With regard to cemeteries, Kansas quietly promulgated a regulation authorizing a $20 per preneed contract fee. Kansas would like to use a portion of those fees to implement a preneed contract database that would provide data that would be used in cemetery audits.

Nebraska also has plans to implement a new preneed database for auditing master trusts. In the absence of funding legislation, the Department of Insurance must use a carrot and stick approach with the state’s larger preneed sellers. Similar to the Illinois approach, the Nebraska stick would be the assessment of audit expenses against the non-compliant preneed seller. Illinois’ recent preneed law change (SB1682) raised the possible assessment from $7,500 to $20,000. For the preneed seller found to have issues of material non-compliance, the costs of a full audit could cost tens of thousands of dollars. And then there’s the issue of funding up deficiencies. As the Illinois law spells out, the audit penalty cannot be paid out of the preneed trust.

For preneed sellers from Illinois to Colorado, it isn’t a matter of whether there will be exams or audits, but when. For some states, those exams will come sooner than others. Missouri is currently training new examiners, and could well release them on those sellers who miss the October 31st renewal deadline.
 

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The financial fallout from the failures of NPS and IFDA regarding compliance with state and federal laws has accelerated the decision of many funeral directors to switch to the non-guaranteed preneed contract. That non-guaranteed contract represents a fundamental change in the relationship that is established between the consumer, the funeral home and the preneed fiduciary.

The trust-funded preneed contract establishes a fiduciary account that has two beneficiaries: the funeral home and the consumer. It is quite common for fiduciaries to administer trusts with beneficiaries with competing interests. With competing beneficiary interests, the fiduciary must look to the trust provisions, and applicable state law, to determine who may exercise discretionary authorities regarding the trust.

State preneed laws are written in response to existing practices, and historically, the guaranteed contract defined preneed practices. When the funeral home sells a guaranteed contract it is the funeral home that assumes the risk of the trust’s investment performance. With that risk, preneed statutes typically vest in the funeral home the authority to establish the trust, to hire and replace the fiduciary, and to participate in decisions such as investments. State preneed laws have generally been vague or silent about administrative and accounting issues, and fiduciaries have turned to the funeral home for instructions regarding accounting and income reporting.

With the non-guaranteed contract, the funeral home has both deferred the sale of the funeral (until death) and transferred the risk of investment performance to the consumer. Appropriately, the consumer may have questions to put to the funeral home, the fiduciary and the preneed regulator:

• Must the fiduciary follow a different investment policy with regard to funds held for guaranteed contracts versus non-guaranteed contracts?
• How is trust asset value allocated to the contracts?
• How is income and expenses allocated among the types of contracts?
• How will income and expenses be reported?

For many funeral homes, the latter issue (the reporting of trust income) drove both investment policies and accounting procedures. No one likes to get a tax statement on a preneed contract, and so many funeral homes went to tax exempt bonds in belief this relieved the trust from reporting income to the consumer. But, the IRS requires tax-exempt income to be reported because it impacts the taxability of social security benefits. If the consumer hasn’t received an accurate statement of income and expenses, his account has exposure for a $50 penalty if the trust isn’t being reported pursuant to a Form 1041QFT. (This accuracy reporting penalty more than likely led the IFDA corporate fiduciary to effect a Section 685 election for all master trust accounts.)
 

For the upcoming wave of non-guaranteed contracts, there are only two permissible methods of reporting income: grantor statements to the consumer or a Section 1041qft. Regardless of which income reporting method is used, the funeral home and fiduciary can not simply park the consumer’s funds in a tax-exempt fund. The preneed trust’s allocation of income and expenses for tax reporting will be similar for both approaches, thus making the trust’s tax return a tool for regulators when evaluating the fiduciary’s administration and accounting.
 

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The Texas preneed regulator may have left some consumers scratching their head. On September 16th, the Department of Banking issued a press release that a cease and desist order had been issued to prohibit a Lubbock funeral home from selling trust-funded prepaid funeral contracts. But, a Lubbock newspaper reported comments from the Department of Banking that the funeral home could still sell insurance-funded prepaid funeral contracts. So, how is the funeral home can sell one form of preneed but not another?

With insurance-funded preneed, the funeral home typically acts as an agent for the insurance company. The insurance company provides a preneed contract form, and establishes procedures regarding the administration of premiums. The insurance company also provides consumer statements and regulatory reports. Essentially, the funeral home has a minor role in the preneed transaction once the insurance application is completed.

With trust-funded preneed, funeral homes either act as their own ‘seller’ or they contract with a third party sales organization. In many states (such as Missouri), the state association master trust is a third party seller and assumes the seller’s compliance responsibilities. Those responsibilities include contract compliance (preneed contract form and trust agreement), consumer payment accounting, trust allocations, recordkeeping, and regulatory reports.

Apparently, the Lubbock funeral home acts as its own seller. DOB auditors cited the funeral home for poor recordkeeping, and the failure to deposit consumer payments. There is nothing in the press release (or news article) to suggest the funeral home was guilty of any criminal act or that preneed funds are missing. It is quite possible the funeral home’s inadequate records contributed to its failure to make the required deposits.

The funeral profession is on call 24 hours a day, seven days a week, and providing service to families comes before everything else. And, for many funeral directors, preneed compliance is an intrusion on the time that should be devoted to families.

But, regulators are warning that if the services offered to families include trust-funded preneed, the funeral home cannot push the preneed paperwork into the bottom drawer.
 

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Regulators in California, Missouri and Kansas have already implemented strategies that are intended to make preneed fiduciaries more accountable to the consumer. Over the past few weeks, this blog has covered new reporting requirements in Missouri and the audit drama playing out in California. In Kansas, the fiduciary for a failed cemetery has been sued for various breaches of state law. Because the pool of experienced preneed fiduciaries is relatively small, the events transpiring west of the Mississippi River will influence many Illinois fiduciaries to spend some time with SB1682.

One SB1682 requirement that has already caused a rift between funeral homes and preneed fiduciaries is the annual statement requirement. Illinois law now requires the trustee to report to the preneed purchaser receipts, disbursements, and “an inventory of the trust” (including expenses).

Recent statements reflected substantial account decreases, and that has strained the relationship between the funeral home and some of its consumers. While funeral homes would rather avoid inflaming consumers with news about deteriorating accounts, the fiduciary is bound by law to provide the consumer an annual accounting.

IFDA members can deflect some consumer complaints, but eventually, the buck will stop with the funeral director. To regain consumer confidence, funeral directors should be prepared to show they have a plan for the funds entrusted with them.
 

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On September 9th, Missouri’s State Board of Embalmers and Funeral Directors conducted its first public meeting since forwarding new (and extensive) reporting requirements to preneed funeral sellers and providers. In no mood to entertain complaints from the industry, the Board advised licensees to “do their best”. In response to criticism of the new trust reporting requirements, the Board advised that fiduciaries are only being required to certify individual account data regarding transactions for which they have oversight responsibilities. Fiduciaries are not being required to certify the preneed contract data for which the seller is responsible (purchaser and beneficiary names and addresses).

What the preneed fiduciary is being required to certify is aggregate trust data regarding deposits, income and expenses. With regard to each preneed contract, the trustee must also certify the 5% origination fee and 10% sales expense that have been paid to the seller, and the market value of each contract. The State Board advised the industry that these reporting requirements will likely change next year. For example, the current report does not contemplate the amount deposited to trust per contract, or whether the preneed contract is guaranteed or not (which is necessary to determine whether the 10% sales expense is appropriate).

The course of reporting requirement changes will be influenced by the industry’s efforts as a whole to comply with the October 31st renewal requirements, and the January 31st voluntary reporting request.
 

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California funeral directors face a September 13th deadline that could have substantial financial consequences, including the repayment of trust distributions.

A July 1st letter sent by the California’s Cemetery & Funeral Bureau to funeral homes in the California Master Trust outlined the regulator’s rejection of the Association responses regarding the Master Trust audit. An impatient Bureau gave funeral directors 3 weeks to respond. That deadline was quickly extended to August 11th. Then the week before the August 11th deadline, the Bureau granted another extension to September 13th.  On the eve of the deadline, there is nothing on the Bureau's website to suggest another extension is in the offering.

The Bureau is demanding several significant changes to be made to the administration of the California Master Trust. But one demand that may prove problematic for the Association will be the Bureau’s demand that funeral homes repay to consumers’ trusts the administration fees that have been paid out over the years. The Bureau has rejected the Association’s proposal for prospective procedures to document the fees.

Within the past year, Nebraska preneed sellers were also called upon to replenish trusts for the method in which income taxes were paid. The Nebraska examinations also went back several years, and involved substantial amounts.

With new reporting requirements, Missouri funeral homes will also have to explain trust and joint account shortages. Some Missouri funeral directors have failed to appreciate how Missouri law distinguishes between trusting and joint accounts. Missouri’s old preneed law allowed sellers who used trusts to retain 20% of the consumer’s payments, and to withdraw income (subject to the mark to market) requirement. Those provisions don’t apply to joint accounts. With regard to the new Missouri law, sellers also need to grasp that the 10% sales expense is permitted only with regard to trust contracts that are guaranteed. With regard to Pre-SB1 trusts, sellers could be held accountable for income, taxes and expense distributions that cause the trust to drop below aggregate deposits.

Illinois preneed sellers have a similar limitation on their claim to the 5/15% permitted under their preneed law. While the lawsuits that have embroiled the IFDA claim about 1/3 of the master trust’s contracts were non-guaranteed, it’s not clear the funeral homes made that distinction when claiming their ‘administrative fee’.

For those funeral directors who participate in a master trust, the California drama is worth watching. While the Association is crucial to negotiating a resolution, the Bureau has taken its fight to the individual funeral homes. Will other state’s regulators follow suit?
 

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Missouri preneed law (past and present) authorizes three forms of funding: trusts, insurance and joint accounts. Of the three, joint accounts have been used by many rural funeral homes that did not want the hassles of trusts and insurance. But with new reporting requirements, these funeral homes are on the clock to pull together information and seek certifications from bankers who, up to this point, haven’t been required to review a preneed contract.

With regard to their joint account funded contracts, the funeral home with a seller’s license has two renewal forms that must be filed by October 31st. The seller renewal form includes a report of contracts sold since August 28, 2009. That report has to be certified by the bank that maintains the joint account.

The provider renewal form requires a report of all active joint account contracts sold prior to August 28, 2009. In contrast to the seller renewal form, this report does not have to be certified by the banker. But, the State Board is requesting that funeral homes with joint accounts file a third report by January 31, 2011. While the January report is voluntary, it will require a bank certification for the number of contracts, the total face of the contracts and the amount paid by the consumer.

The refusal (or failure) to file the voluntary report will likely affect the nature and timing of the funeral home’s financial exam. The State Board has to perform a financial review of each “seller” once every five years. The State Board also has the authority to perform a financial review of providers. Regardless of whether the funeral home gave up the joint account contract when SB1 went into effect, the State Board will eventually review the contracts and accounts listed on the Provider renewal form that is due on October 31st.

In preparing the joint account reports, funeral homes need to read the instructions carefully. The forms are seeking information about the contracts sales price, what was deposited to the joint account and any distributions that have been made. Unlike trust-funded contracts, all consumer payments have to be deposited to a joint account (there is no 20% retainage for the joint account contract). Nor may the funeral home withdraw income from the joint account.

For the funeral home that takes the defiant stance about their preneed, be sure your contracts and CDs (or depository accounts) are in order. If you have doubts about the compliance of the contract forms or the amount in the bank, you may want to seek guidance from the Board’s inspectors.
 

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In August 2009, the members and staff of the Missouri State Board of Embalmers and Funeral Directors put in a lot of overtime to keep the preneed industry operating. Senate Bill 1 established brand new licensing requirements for preneed sellers. Without a license, a seller’s preneed contracts could be voided. However, the State Board lacked authority to issue a seller license until SB1 went into effect. With regard to August 28, 2009, the State Board faced the task of licensing hundreds of funeral homes, and responded by providing the industry an abbreviated process for obtaining the initial preneed seller’s license.

With the renewal of a seller’s license, the Missouri funeral home faces a much longer and detailed form (and process). The seller renewal form advises that the applicant may file their annual report upon receipt of the form. Realistically, the seller is precluded from filing the renewal and report until after September 1st. The annual report must include all contracts sold through August 31, 2010 (and beginning with August 28, 2009).

Depending upon how quickly its contracts are processed, the seller will have less than 60 days to work with trustees, banks and insurers to pull together the data and documents required by the renewal form. The failure to timely file the renewal form and report will cost the seller $200 and the authority to sell preneed until the license is renewed. Consequently, Missouri sellers would be best advised to begin working with their funding entities as soon as possible.
 

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Families and funeral homes harmed by NPS will hope that company’s owners and officers have to face a judge like the Honorable Richard Rome.

The Hutchinson News reported that District Judge Richard Rome rejected a plea bargain for probation, and sentenced Fairlawn Burial Park’s owner to almost 5 years in prison. A Kansas Secretary of State audit of Fairlawn’s permanent maintenance trust and preneed merchandise trust found several hundreds of thousands of dollars missing. The owner’s attorney suggested the funds were used to keep the cemetery operating.

While prosecutors negotiated a deal to replenish the trusts, the judge disregarded the plea bargain and sentenced Ms. McDonough to prison. The message to operators is that if the cemetery needs funds for operations, don’t borrow them from the trusts.
 

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While the reasons are open to debate, it is common knowledge within the funeral industry that a small percentage of consumers cancel their preneed contracts. Consequently, some funeral directors tend to view their preneed block of business with a degree of certainty. Performance of the contracts, and recognition of the revenues, seems to be just a matter of timing. A few state laws reflect the perception that performance of the preneed contract is a ‘lock’. For 37 years, Missouri law allowed preneed sellers to withdraw trust income. Nevada’s law has similar provisions. Preneed trust income became a source of funds that could subsidize funeral home operations.

While the preneed subsidy had long been a source of frustration for certain Missouri officials, they were powerless to stop the practice until the failure of National Prearranged Services. With the 2009 passage of Senate Bill No.1, Missouri officials feel they have a law that they can use to force a new business model upon the funeral industry.

In the case of the California Master Trust, the Department of Consumer Affairs has taken a similar position with regard to an administrative fee that has been paid to participating funeral homes for decades. Consistent with the historic industry view, the CFDA response relies in part upon the preneed guarantee and the risk assumed by the funeral home.

The position becomes tenuous when the administrative fee is judged on terms of whether a necessary service has been rendered to the trust, and whether the amount paid is reasonable for the services received. It is apparent from the documents that the DCA will also apply that analysis to what the CFDA has charged the trust. Depending upon how this controversy is resolved, other states’ regulators may ask whether the administrative fees charged to the master trust are appropriate.

As a recent Funeral Service Insider comment suggests, some industry associations have also become dependent upon the preneed subsidy. The classic guaranteed argument loses traction when facts such as those in Illinois emerge. By one account, non-guaranteed preneed contracts accounted for one third of the contracts administered by the IFDA.

But, in defense of the CMT, preneed trusts are labor-intensive enterprises where the funeral home, administrator and fiduciary have shared responsibilities. In its challenge of a different CMT issue (the maintenance of preneed records within California), the DCA acknowledges this reality while discussing the funeral home’s recordkeeping duties. Effective field examinations will require that certain preneed records be maintained at the funeral home. But, is it reasonable to impose greater administrative requirements on the funeral home without allowing any compensation to be paid to them?

The emerging regulatory challenge to the preneed subsidy is premised on the position that the funeral home’s right to preneed funds does not vest until the contract is performed. That position is consistent with Missouri’s efforts to improve portability. But, regulators must also find a consistent and reasonable position with regard to the services that they mandate from the funeral home. 

(The Funeral Service Insider excerpt was included by special permission from Kates-Boylston Publications and Funeral Service Insider.)

 

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In contrast to how the IFDA situation was handled, the California Department of Consumer Affairs has taken a public approach to disclosing its issues with the CFDA’s master trust by posting its website an audit report and the Association’s reply.

The DCA is unhappy with the Association, and the master trust fiduciary, with regard to (among other things) the fees that have been charged to the trust, the authorities that have been delegated by the fiduciary, and their refusals to respond to certain audit inquiries and document requests.

The audit report reflects a very literal interpretation of the applicable California laws. A close reading of the report should leave one scratching his/her head on a few of the issues (hint: corpus issues). But, auditors have no choice but to apply the laws that are applicable to the entity under examination, and unfortunately, the California preneed law and rules are dated and disjunctive.

For those who summarily advise that the audit report and the DCA actions reflect yet another example of a preneed program gone bad, that is not the case.

The DCA website includes the April 29th response from the law firm representing the Association. I doubt the attorneys knew that the letter would end up on the DCA website, but the reply is very illustrative of the issues that exist with a dated, and ambiguous, law. While the Association has made some serious missteps with regard to some of the law’s ambiguities, the auditor’s interpretations of the law and its requirements are inconsistent or unreasonable in some respects. Accordingly, the DCA would be well advised to accept the offer extended in the “Conclusions” on page 46 of the reply.

The crucial issues raised by this dispute are relevant to all master trusts, and will be addressed in future posts. Hopefully, the DCA will continue to make the discussions and eventual resolutions public so that death care regulators and preneed program administrators can take note.
 

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Several states have passed laws in the past few years mandating greater preneed oversight. But with state budgets in decline after the 2008 market crash, regulators are hard pressed to find a way to pay for consumer protection.

Colorado’s new law simply states that the contract seller shall bear the cost of its examination.

In failed legislation earlier this year, Kansas sought to finance preneed cemetery oversight through a per contract fee. Sources indicate that Kansas will attempt to implement a $20 per contract fee later this year through new regulations.

Missouri took a hybrid approach last year through seller/agent/provider license fees and a $36 per contract fee. Ten months into the mission to provide preneed oversight, the State Board of Embalmers and Funeral Directors do not have enough data to know how well this approach will work. The first reporting period is still four months away, and no one knows how many preneed contracts have been sold since August 28th. As a consequence, license fees will likely be increased, which hits the smaller operator the hardest.

In a 180 degree change from last year, the State Board is mulling whether to increase the per contract fee, knowing that most sellers pass that fee on the consumer. In response to pressures from consumer advocates, the State Board had originally taken the position that sellers should be required to absorb the $36 fee. The reality is that the costs of preneed oversight are passed on to the consumer in one form or another by the preneed seller, and the per-contract fee provides transparency to the consumer.

Agencies, such as the State Board, that are charged with licensing preneed sellers and agents, need to charge some form of fee to cover the administrative costs of licensure. However, there is justification that the transaction (i.e. the consumer) should primarily bear the cost of examinations and oversight. On the other hand, it is not equitable that consumers bear the costs of disciplinary proceedings for the operator that fails to materially comply with the law.

With the per-contract fee, consumers and operators are provided a clear benchmark of the costs of their state’s preneed protection program. Such a fee will place a burden on regulators who must budget for fixed program costs (such as dedicated staff).
 

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The Comptroller’s Office mailed out letters to funeral homes last week advising how to report the first contribution to the Pre-Need Funeral Consumer Protection Fund. The letter tracks the first few paragraphs of the “Senate Bill 1682 Information” page from the Comptroller’s website.

The funeral home letter includes two documents: a Fee Payment Record and a Bank Confirmation Form. For each contract sold, the funeral home must deposit $5 to the Consumer Protection Fund. The $5 may be funded out of the consumer’s payments. The Fee Payment Record will be used to record each pre-need contract for which the funeral home has made a deposit.

The Bank Confirmation Form is intended to establish an audit trail for the mass exodus of preneed funds from self trusted accounts, and from the IFDA master trust. This form serves to put funeral home’s pre-need trustee on notice that it will be required to provide records to the Comptroller’s Office.  

The Comptroller’s letter to funeral homes omits information that the website page provides consumers. Fiduciaries that are accepting Illinois pre-need trusts should take note of the Comptroller’s consumer information:

Notice to Consumers --- Your independent trustee must provide an annual notice to all consumers of the status of their funds including an explanation of any fees charged by the trustee, an explanation of the purchaser’s right to a refund and identification of the primary regulator of the trust or insurance company under state or federal law. Here are some suggestions for ensuring compliance with the new provisions:

· Be sure the corporate fiduciary or insurance company that you use is aware of this requirement.
· Be sure the corporate fiduciary or insurance company provides you with a copy of the annual notice.
· Retain a copy of this annual notice in your file.

Historically, preneed fiduciaries have defined their duties by treating the death care operator as the trust beneficiary, and the trust as a single account. The Comptroller’s trustee requirements reflect a trend that forces the fiduciary to factor the consumer into the beneficiary equation, and to provide an accounting on an individual contract basis.

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Missouri funeral homes will get their first glimpse of their State Board's proposal for self reporting for preneed sales.  Under the prior law, preneed sellers merely reported the number of contracts sold and their aggregate sales price. 

For Missouri regulators to properly assess whether 'old' Chapter 436 trusts and joint accounts are properly funded, the new reporting requirements will have to ask for data that funeral directors may find intrusive.  But the state with the trusting requirements closest to Missouri's has been self reporting for many years. 

Iowa makes its reporting forms available through its website.  Preneed sellers, preneed agents, insurance companies and banks each have their own reporting form. 

By addressing the forms now, Missouri's State Board will be affording funeral directors 3 months to prepare reports on all existing business.  Depending how well the funeral home has kept its records, this should be adequate to meet the October 31st deadline.

Funeral homes that used either trusts or joint accounts under the prior Missouri law may want to look at Iowa's form to anticipate what individual contract data could be required.  The Iowa forms also provide instructions and Q&A sections. 

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The next round of legislative proposals have been posted to the State Board of Embalmers and Funeral Directors website. At the top of the list is whether the trusting requirement should be raised from 85% to 100%. The proponent believes this will enhance consumer protections. He is not alone.

The Illinois Legislature heard the same from Rep. Dan Brady last year. And, the Funeral Consumers Alliance has been advocating the same position for years. But, does this requirement truly enhance consumer protection?

Competition dictates the type of preneed program a funeral home maintains. Metropolitan funeral homes often have no choice but to maintain proactive programs that require training, marketing, management and dedicated staffing. To offset program costs, the funeral home must receive revenue from the preneed sale. Setting the trusting requirement at 100% forces the funeral home towards insurance products, and their commissions. A legislative agenda that forecloses the trusting option makes little sense when insurance played a major factor in both the NPS and IFDA failures.

For the consumer’s perspective, a major weakness in the old Missouri law was the preneed seller’s right to withdraw income from the preneed trust. Without the accrual of income, the preneed contract became less portable as it aged. While SB1 may have other trust issues to address, it did fix the income accrual issue.

Some have argued that SB1 did not go far enough in providing the consumer refund rights to the income earned by a trust. The seller of the guaranteed contract is afforded the right to retain the income on cancellation because he takes the risks associated with the price guaranties. But prior to SB1, there was little authority for the non-guaranteed contract. If the preneed purchaser places a premium on refund rights, then the non-guaranteed contract authorized by SB1 is the better option.

With regard to Illinois law, the glaring weakness regarded the self-trusting provision and the lack of fiduciary oversight. With trusting already set at 95%, many larger funeral homes were already dependent on insurance funding. Deprived of revenues to maintain a trust program, funeral homes relied upon the IFDA. The lack of oversight and transparency lead to abuses by past IFDA leadership.

SB1682 took the crucial steps of requiring corporate fiduciaries, and imposing the prudent investor rule. But a question remains about who should provide oversight to the preneed fiduciary.

So, how does 100% trusting further enhance consumer protections in either Missouri or Illinois?

The debate over insurance versus trust has been waging for twenty years. While each has its strengths and weaknesses, the death care industry has done little to offer the consumer meaningful options for funding and price guarantees. Establishing barriers to either form of funding (or to non-guaranteed contracts) will do little to enhance consumer protections.
 

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Small town funeral homes often lack the volume of business to warrant a ‘preneed program’. And, if there is no competition, why hassle with the costs of preneed compliance. The short answer is reputation and integrity.

A recent article about an Iowa funeral director suggests the operator may have only handled a hand full of preneed transactions a year. But rather than establish a trust, he placed the consumer’s funds in the funeral home’s operating account. Insurance policies were also handled improperly.

These ‘issues’ began to surface with the annual report filed with the Iowa preneed regulator a year ago. The next annual report suggested further problems, and now the operator must pay a civil penalty of $2,500, bear the expense of a CPA audit and a new trust. This is a stiff penalty for a small business, but not such that would put the operator out of business. As the comments to the article suggest, the greater hit could be to the operator’s reputation.

 

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The Wall Street Journal has long been viewed as a leading source of business and investment news. But last weekend, the WSJ ran a short article on preneed, and demonstrated its lack of understanding of the transaction.

The article attempts to characterize preneed as an investment, and then explores issues such as cash surrender charges, cancellation penalties and the NPS failure. This is all very misleading because preneed is not an investment, or a security, but rather the purchase of funeral goods and services.

Those who are considering the purchase of preneed should not view the transaction as an investment. The Securities Exchange Commission determined decades ago that the transaction is a purchase of goods and services, not an investment. While the transaction may be entered as a ‘hedge against rising costs’, there are forms of preneed that do not provide such protections.

The WSJ article ends with advice that also misses the mark. An elder law attorney suggests that a simple trust, costing “a few hundred dollars”, could substitute for the preneed transaction. Unless the attorney is considering individual trustees who serve without compensation, the combined cost of the trust document and the initial corporate fiduciary fee could be several hundred dollars. The corporate fiduciary will then have a minimum annual fee that will be ‘a few hundred dollars’.  With a corporate fiduciary, this rather simple plan could end up costing 'a few thousand dollars'.

The next time the WSJ reports on preneed, it should do its homework, and not use the transaction as weekend filler.
 

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Give the State Board credit for attempting to clarify how insurance assignments must be handled for compliance with Missouri laws. 

For several months, the State Board has sought clarifications from MO HealthNet regarding spend-downs. On May 12th, the Board emailed to the industry new MO HealthNet guidelines for insurance assignments. One day later, the legislature passed HB 2290.

HB2290 addressed a gaping hole left in Chapter 208 when SB1 was passed. Chapter 208 excluded funeral contracts that complied with Chapter 436 provisions that no longer exist. The drafters of HB2290 took a broad-brush approach to the problem. Having done so, funeral homes and cemeteries are left to ask MO HealthNet and the State Board new questions.

 

By the bill’s reference to Chapter 436, must a “Burial Plan” or “Preneed contract” comply with the requirements of SB1? This would be a defeat for cemeteries who have the option of selling preneed under Chapter 214. 

 

If an insurance policy was not purchased with the intent to fund a preneed contract, why then, bring the true spend down into Chapter 436 (and further burden the Board’s oversight functions)?

The MO HealthNet guidelines can be found on the State Board’s website.

 

Missouri funeral homes should note that the guidelines impose a duty on the funeral home to notify the Department of Social Services when excess funds remain from a participant’s preneed contract. If the preneed contract was irrevocable, that should flag to the funeral director that he should make an inquiry. 

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For more than 20 years, Nebraska preneed sellers have filed an annual report that accounts for the aggregate contributions and distributions from their trust funds. The annual report form also computes the amount of income that must be accrued to the account if the seller elects to withdraw excess income from the trust. In its quest to determine whether preneed trusts are adequately funded, the Department of Insurance has made a request for individual contract data that supports the annual report.

Nebraska’s request for individual contract data reflects a trend developing with other Midwest death care regulators.

Individual contract data reporting was a priority in failed legislation by Kansas regulators.

Missouri’s State Board of Embalmers and Funeral Directors has acknowledged the need to determine whether existing preneed trusts are adequately funded, and that objective requires some detail about what comprises the trusts established under the prior law.

Missouri cemeteries are about to embark on preneed sales under a new law, and regulators have already expressed a need to know about those sales.

While many death care operators may challenge the individual account data request as burdensome or intrusive, operators harmed by NPS or the IFDA insurance debacle, have reason to be providing such information.

The degree an NPS provider suffers ‘damage” by honoring a preneed contract depends on several factors: the age of the contract, the casket, the funeral home’s current atneed prices, to name a few. To challenge that more than the guaranty association payout is needed, the industry must be willing to provide hard facts based on actual contract data. If the active NPS contracts are included in a state’s annual reporting, a basis has been established for a database for tracking the NPS consequence to the industry.

The same is true for Illinois funeral directors seeking to recover for the IFDA asset meltdown. Recovery has to be based on contract data.
 

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Missouri's funeral industry has been given 30 days to submit proposals for revisions to the preneed law that went into effect last August 28th.  By email, the State Board has provided the guidelines for submitting changes that will then be discussed by the Board at public hearings to be held in June.  The Board has it's own July 15th deadline to adopt any of the proposals and submit them to the Division of Professional Registration. 

For those operators who are displeased with the new law, the clock is running.

 

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The Springfield Journal-Register recently reported that Illinois' Cemetery Oversight Task Force made a recommendation to restrict preneed trusts to investing in government-backed securities.   While its difficult to actually find that recommendation in the Task Force's report, it is not a bad idea for the consumers who purchased a non-guaranteed preneed contract.  However, that type of restriction would hinder funeral homes that offer guaranteed contracts.

The safety provided by government-backed securities comes at a premium: a lower investment return.  Funeral homes and cemeteries are encountering cost increases that recently have outpaced the returns seen from insurance and trusts.  With regard to preneed trusts, investment return has often lagged behind cost increases because tax issues have been allowed to dictate investment policies.  

In the case of the IFDA, the trust resorted to insurance.  It is also very common to find preneed trusts invested exclusively in tax exempt bonds.  

If funeral homes and cemeteries are to offer guaranteed preneed contracts, applicable law should require trusts to adhere to the prudent investor rule.  While these trusts will always favor an asset allocation heavy with fixed income securities, a diversification is needed to provide protection and reasonable returns.  

 

  

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The General Laws Committee of the Missouri Senate will hold a hearing this Wednesday (April 7th) on SB 1025. This bill provides hope to many small, rural funeral directors who would rather avoid the preneed transaction and the regulatory morass of SB1.

The bill would add a new Section 208.010.5 whereby individuals seeking to spend down assets to qualify for assistance could establish an irrevocable trust of up to $10,000. The trust could only be used for funeral and burial expenses. The section would also exclude the arrangement from Chapter 436.

When a similar provision was included in last year’s SB1, the funeral directors association expressed concern that the arrangement would be abused. However, the requirements of SB1 have proven burdensome and confusing to the industry, extremely so for the funeral home that only accepts “pre-arrangement funds” as an accommodation.

A Chapter 208 final expense trust would provide the consumer and his Missouri funeral operator a much-needed alternative to the joint account contract.
 

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A recent news report titled “Broken Trust” served to fan the emotions of Illinois residents who purchased a preneed contract from the Illinois Funeral Directors Association. The facts involve a 103 year old lady who purchased the contract 16 years ago, and experienced a 32% drop in the contract’s value in one year. The news report quotes from the funeral home’s website:

“By locking in today’s funeral costs and ensuring that the necessary funds are set aside, you help relieve yourself of unnecessary future worry and your survivors of an unexpected expense.”

The news report then adds: “For the Graces and thousands of other families in Illinois, it did not work that way.”

The news report goes on to add commentary for consumer advocates advising against the purchase of preneed. However, the news report is very misleading and serves to confuse consumers because of an important fact: Mrs. Grace purchased a non-guaranteed contract.

Contrary to what the article suggests, the Grace family did not lock in the 1994 purchase prices of the funeral home’s goods and services. They have every right to be upset about the recent drop in value, but so do hundreds of Illinois funeral homes.

Over the course of 16 years, Mrs. Grace’s preneed contract has realized an increase of 1.66%. Not a great return. The goods and services selected in 1994 to have gone up at a rate of 4.2%.

While a difference of $4,500 may exist between the value of Mrs. Grace’s contract and the current cost of the 1994 goods and services, the Grace family is not obligated to purchase that same funeral.  The family may choose less expensive goods and services.

The Illinois Comptroller has published various consumer guidelines regarding preneed contracts. All have an explanation of the differences of guaranteed and non-guaranteed.

To avoid unnecessary distress, consumers should read available disclosures closely, review the preneed contracts, ask questions of the funeral director, and involve other family members in the process.

For Illinois families who own a non-guaranteed preneed contract with diminished values, if you demonstrate flexibility over the casket selection, most funeral homes will reciprocate with regard to their services.
 

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Within the past few years, state legislatures have significantly expanded the fiduciary duties of banks and trust companies that service death care trusts. Michigan, Indiana and Tennessee responded to cemetery trust frauds (including the Clayton Smart affair). The trend continued in Missouri and Illinois with laws aimed at funeral trusts (in response to NPS and the IFDA master trust). And, Kansas joined the movement with bills that are in response to cemetery trust failures.

At hearing for Kansas HB2712, the Kansas Bankers Association endorsed a provision that would require Kansas cemeteries to use fiduciaries that maintain a physical location within the state. The KBA reasoning is very simple: Kansas jobs. While the Kansas Secretary of State will accept the KBA’s support, the regulator wants the domicile requirement because the local fiduciary will be more responsive to the auditor’s inquiries and demands.

Regulators are not alone in their preference for the local bank. Funeral homes and cemeteries also take comfort in dealing with the bank that also handles their commercial accounts and their loans. Many funeral directors report that consumers also take comfort knowing their preneed funds are being supervised by the same banker who provides them checking services. Even consumer advocates recommend that individuals use the local bank to set up Totten trusts or POD accounts in lieu of preneed contracts.

However, the preneed trust and the cemetery perpetual care trust are not the type of accounts that most banks (or trust companies) handle with sufficient frequency to develop expertise. There is very little in the way of guidance to banks other than a 2000 memorandum issued by the Office of The Comptroller of the Currency to national banks.

Buried in the details of the OCC memo is the devil that trips up many preneed fiduciaries: the bank will be required to administer and invest the trust pursuant to the controlling instrument and applicable law. Applicable law would include the Internal Revenue Code, 12 CFR Part 9 and state death care laws.

The OCC memo warns national banks that:

Many banks serving as trustee in a preneed trust have only limited contact with the purchaser of the funeral contract and provider of the trust funds. The bank’s contact and business relationship is primarily with the funeral company. The consumer’s primary contract is with the funeral company or funeral director. Upon the death of the consumer, the bank remits the proceeds of the trust to the funeral company in accordance with the terms of the trust and contract, not to the individual’s family or heirs as is common in most trust relationships.

What makes this complicated and sensitive is that preneed funeral trusts are usually accounts established by funeral homes on behalf of individuals who are elderly or have limited financial resources. In addition, trustees manage these funds for a particularly sensitive and emotional event. Absent appropriate policies, procedures, controls and monitoring systems, this business line can create increased transaction, compliance and reputation risks.

Poor management of preneed funeral trusts, including weak internal controls over account acceptance and disbursements, noncompliance with trust agreements and applicable law, and inadequate due diligence on funeral homes and directors, can negatively affect a bank’s reputation. Banks that align themselves, or are affiliated, with funeral companies that have or subsequently develop reputation problems may themselves be tarnished, even if their internal practices are appropriate.

Preneed funeral trusts require the same level of supervisory oversight and risk management systems as other fiduciary activities in national banks. We expect banks that are active in this line of business to have appropriate strategic plans, policies and procedures, internal controls, MIS, and monitoring systems for this product. The administration of these accounts must comply with 12 CFR 9, Fiduciary Activities of National Banks, particularly the pre-acceptance, post-acceptance and annual review processes. It may be appropriate to have policies and procedures specific to this business line, and, if the business is significant for a bank, a separate administrative and investment review committee should be established.

It is imperative that national banks perform due diligence reviews on a funeral company before they enter a business arrangement with it. Bankers should also perform annual reviews of companies with which a bank has established a business relationship. Bankers should administer the use of third party service providers, such as investment advisors or managers, with appropriate controls and monitoring systems. National banks should also include preneed funeral trusts in internal compliance and audit programs.

While everyone from the consumer to the state death care regulator may take comfort in the local banker, few small institutions will have the revenues sufficient to warrant the costs associated with the compliance procedures recommended by the OCC.
 

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In rejecting the $18 million settlement forced upon IFDA members, an Illinois Circuit Court is telling Merrill Lynch Life Agency to dig deeper into its pocket to compensate funeral homes. As reported by the Springfield Journal-Register, the $18 million represents the revenues the insurance broker received from the sale of key man insurance to the IFDA master trust. Apparently, Merrill Lynch convinced the Illinois Department of Insurance (DOI) that the funeral homes’ damages should be measured in terms of the benefit that Merrill Lynch received. But as the editor of the Memorial Business Journal* suggests, the Circuit Court seems more inclined to consider a ‘deeper’ measure of damages, and that will require the parties to the litigation to assess the master trust’s true loss.

The master trust collapse is framed by a ‘value’ that was set by a fixed return (2%) on consumer deposits. Based on that ‘value’, the loss is reported to be close to $100 million. But, one question funeral directors may be forced to answer will be whether the trust could have attained that value with the investment restrictions imposed by the members and the expenses taken by the IFDA. Another issue that may be raised is whether the IFDA’s past executives and attorneys bear some of the responsibilities for either selecting the investments or approving them. If so, comparative negligence may force the IFDA to shoulder responsibility for a portion of the damages.

The situation begs for a negotiated settlement, and it is unfortunate that time and expense was wasted on an end run with a regulator that had little, if any, authority over the IFDA master trust.
 

*"Reprinted with permission from the March 4, 2010 issue of the Memorial Business Journal. To subscribe please call 609-815-8145."

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With two of the nation’s top ten college basketball teams, Kansans are exhibiting clear symptoms of March Madness. With Topeka located between Lawrence and Manhattan, bipartisanship may be tested as tensions mount this week with the Big 12 tournament and the NCAA seedings announcement on Sunday. When Kansas legislators resume their meetings the week of March 15th, they may hear from a third constituency that has a different ‘madness’ in mind: the Secretary of State’s cemetery legislation.

When the Secretary of State’s staff began holding hearings last June, HB 2712 and HB 2713 may not have been what they had in mind. With the intent to encourage industry input, the Secretary of State formed a committee of cemetery operators and state representatives that was to meet for an afternoon every two weeks. With an aggressive agenda in hand, the first meeting included a handful of ‘spectators’. After that initial meeting, attendance dropped and fewer cemetery operators participated in the process.

Undaunted, the Secretary of State staff held its meetings over the course of the summer and fall of 2009, and outlined the problems with enforcing Kansas’ cemetery laws: funding for audits, wholesale trusting requirements, ambivalent and uninformed fiduciaries, and underfunded cemetery trusts. At the conclusion of the committee meetings, the Secretary of State requested assistance from Kansas’ cemetery industry. When nothing concrete was offered by the industry, the Secretary of State offered options between a state-mandated trust or revisions to fix the current law. That portion of the cemetery industry that attended the meeting choose a fix of the current law.

Among the changes proposed by the legislation, the following may prove the most controversial to some cemetery operators:

• The filing of monthly reports to the Secretary of State
• A new fee based on the reported transactions
• A switch of preneed merchandise trusting from wholesale costs to 50% of retail
• A new fiduciary definition that will limit the institutions that may serve as trustee
• An expansion of the fiduciary’s duties

While these bills do not reflect what the Kansas Secretary of State had hoped to accomplish when the process began last summer, the legislation reflects the realities of the current environment: growing political pressure to provide consumers greater protections and a fragmented and diverse cemetery industry.   Despite how some operators may respond, the Secretary of State could have gone much further (and may in future years).
 

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The fear of SB1 drove the Missouri cemetery industry to push for Chapter 214 legislation in 2009, only to have the wheels come off at the stroke of midnight last May. While legislation was passed, the original bill was gutted, and the resulting changes were incoherent and confusing. It was no surprise that the industry would pursue a bill to correct what was done in 2009.

An industry bill was introduced in the 2010 session as SB754. However, that bill was quickly replaced by a Senate Committee Substitute. The substitute bill incorporates changes sought by the State, the speed in which the bill was produced signals regulators’ recognition that Chapter 214 reform is needed.

Over the next several weeks, the death care industry and consumers need to take a close look at SCS SB754. Legislators will only provide the parties so many attempts to ‘get it right’. And while this bill contains several needed changes, it also has provisions that beg for questions, and answers. Take preneed for an example.

Section 214.387 will govern how the cemetery industry is to sell preneed in Missouri. Prior to last year’s legislation, Chapter 214 provided minimal oversight of preneed sales of markers and services. If a cemetery wanted to sell a vault on a preneed basis, it had to comply with Chapter 436. Chapter 214 did not contemplate trust funded preneed.

Section 214.387 takes a page from the ‘old’ version of Chapter 436 by requiring Missouri cemeteries to deposit 80% of a consumer’s payments to an escrow account or a trust if the preneed contract defers delivery. Last year’s model of 214.387 first established the new trusting requirement, but did so with confusing language. So in a sense, Missouri cemeteries went from zero to eighty last year without guidelines.

SCS SB754 attempts to provide some of those guidelines, but it misses a few beats.

The 80% trusting requirement will be one of the highest in the country. Many states’ cemetery laws trust on the wholesale costs of merchandise. This poses an audit nightmare (ask the Kansas Secretary of State). The wholesale threshold is crossed somewhere around 40 to 50% of retail. Consequently, the cemetery laws generally have lower trusting requirements than that imposed on funeral homes. But the second piece of the puzzle for cemetery trusting is the income accrual provisions.

Cemeteries have cash flow requirements that differ from that of a funeral home. States’ cemetery laws reflect this by permitting the disbursement of preneed trust income. Typically, the higher the trusting percentage, the more likely income disbursements will be allowed. But, there are exceptions (Iowa for example).

So, it’s no surprise that 214.387 contemplates income distributions. However, the bill only authorizes income disbursements from escrow accounts. The bill does not include a corresponding authority for preneed trusts.

Another glitch in 214.387 would provide consumers a refund that would include half of the income earned on the account. If escrow accounts are distributing income to cemeteries, then someone would have to ‘come out of pocket’ for refunds to the consumer.

The quick solution to these 214.387 issues would be to allow both types of accounts to distribute half the annual income, leaving the balance of income in the account until the contract is canceled or performed. As such, the Missouri law would provide higher trusting safeguards than most other states.
 

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 NPS salesmen had quite a reputation. Commission driven, some were reported to have earned a healthy six-figure salary. And, some had no prior experience in the funeral industry.

To curb the excesses committed by NPS salesmen, Missouri preneed reform bill requires preneed salesmen to be licensed, with a condition that they “have successfully passed the Missouri law examination as designated by the board”.

Since the effective date of the law (August 28th), preneed agents have been required to take the same law examination required of funeral directors. That examination has proved difficult for many preneed agent applicants, and issues were presented to the Missouri State Board of Embalmers and Funeral Directors at their February 4th meeting. The State Board held an open meeting by conference call on February 11th to facilitate further discussion of preneed agent licensing and the Missouri Law Test.

Two basic positions emerged during the February 11th conference call. The funeral directors’ camp views the preneed contract as the sale of a funeral, which should require the licensed funeral director. The proactive preneed seller views the preneed contract as a funding vehicle to pay for the goods and services described in the contract, which would require the salesman to be knowledgeable about the requirements of Chapter 436.

Historically, most Missouri preneed contracts were of the guaranteed variety. If the preneed contract was performed with little or no variation to the prearranged funeral, then the contract represents the purchase of a funeral. But, some families change the terms of their preneed contracts, and under such circumstances, the contract represents a funding vehicle. As more non-guaranteed contracts and final expense products become more common, fewer preneed contracts will represent the “sale of a funeral”.

For the time being, the State Board will continue to require the same law examination given to applicants for a funeral director’s license. But, is the funeral industry best served by restricting preneed agent licensing to legal testing imposed on funeral directors?
 

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The future of Missouri’s examination of preneed books and records will begin to take shape on February 4th. The State Board of Embalmers and Funeral Directors has put this issue at the top of its agenda for Thursday’s meeting.

Regulatory review of Missouri’s preneed industry has been dormant for almost 15 years, and SB1 now imposes a regular examination of preneed sellers’ records. The scope, and the procedures, of the review process may take months to determine, but Missouri funeral directors should anticipate reporting requirements that impact all preneed contracts subject to Chapter 436.
 

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The ICCFA’s November Magazine included an article by Craig Martin that provides good advice for all death care trusts. Death care trusts are notoriously bad performers, and if operators are to improve investment performance they need to work more closely with their fiduciaries and portfolio managers. Mr. Martin offers 5 tips that are equally applicable to preneed trusts and endowment care trusts:

1. Know your investment guidelines (and statutory limitations)
2. Communicate with the investment manager on a regular basis
3. Use a professional fund manager
4. Include growth in the asset allocation
5. Explore the availability of a master trust

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With some industry members having already declared the preneed transaction dead, a recent AARP bulletin reports that the patient is not only alive, but it is regaining its strength. But, the reason for increasing preneed sales will only bedevil many death care operators: the rising costs of funerals.

Operators who face preneed competition will have difficulty swearing off the guaranteed contract if consumer advocates such as the AARP begin to recommend the transaction as a way for seniors to control future costs.

While the AARP’s stance on preneed may be moderating, the bulletin offers advice that consumers should heed:

• Visit at least three funeral homes and ask lots of questions.
• Ask for a detailed price list of products and services.
• Examine the insurance policy or trust documents that fund the preneed contract (even have a lawyer review them).
• Make family members aware of the funeral plans, and keep all documents and receipts in an accessible place.

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A “Spend Down” is the transaction where a person seeking public assistance transfers money or insurance to a funeral home to avoid having the “asset” count as a resource. It is a commonly held perception that the Spend Down accounts for many preneed contract purchases. But should all Spend Downs trigger the state preneed law intended to protect the consumer? That question has been the source of disagreement and confusion for Missouri funeral directors since last July when the State Board first began to implement SB1.

The Missouri controversy swirls around the Spend Down that involves an existing insurance policy. It is a fairly common occurrence for a family to approach the funeral director with a small life policy ($10,000 or less) with a request that the policy be held until welfare applicant’s death (when it is to be applied to funeral expenses). Missouri’s public assistance policies are interpreted at the county level, and the result has been widely diverging requirements. Some Missouri counties require the funeral director to provide a contract to the family to evidence the assignment was not made as a gift. The contract requirement also serves to protect the funeral director by setting out the terms and conditions underlying the assignment. For example, the funeral director may not necessarily promise the insurance policy is being accepted as the sole consideration for the future costs. If the policy proves worthless, the family will still be obligated to pay for the funeral.

The Missouri State Board of Embalmers and Funeral Directors has grappled with whether this transaction should be subject to the requirements of SB1. During it’s initial SB1 meetings, the State Board leaned towards excluding the Spend Down from SB1, but in subsequent meetings expressed an intent to include the transaction if a contract were involved.

When the family approaches the funeral director with an existing insurance policy or certificate deposit, and the funeral director receives no compensation in the form of a commission, the Spend Down represents an accommodation to the consumer. Under such circumstances, a regulator should consider whether the licensing requirements are sufficient to protect the consumer. Imposing the requirements of SB1, or any preneed statute with additional fees or costs, on an accommodation transaction burdens both the consumer and the funeral home.
 

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1. Losing 20 pounds
2. Quit smoking
3. Spend more time with the family
4. Find an independent trustee

And so goes the list of New Year resolutions for the Illinois funeral director, with the last being forced on the industry by SB 1682.

Funeral directors and consumers can learn more about the new independent trustee requirements by visiting the Comptroller's website for SB 1682 information and  SB1682 FAQ issues .

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It is an all but too familiar news report about 60 Michigan preneed contract purchasers having lost all their money, the industry response described the protections afforded by state law.

The MFDA statement drew some rebuke on an industry chat page, including one post recommending that state FD associations take a greater role in educating the public. However, consumer advocate groups will readily acknowledge that “educating the public’ on the risks of the preneed transaction is a difficult task that often occurs after the fact.

The MFDA offers good advice regarding the protections provided by Michigan law, but consumer advocates would be more impressed if the association offered that same advice on their website, and through printed disclosures at member funeral homes.

Once the preneed contract is sold, the industry has long felt it was best to limit communications with the consumer. This ‘perception’ was reflected in the following assertion made in one of the lawsuits filed against the Illinois Funeral Directors Association:

One of the benefits of the Preneed Trust Tax-Exempt Fund was to avoid reminding the preneed customers of their own mortality with an annual mailing of an interest reporting form (Form 1099). The mortality concept has always been critical to the satisfaction of preneed customers insofar as it allowed choices to be made by the customers while sparing their survivors the emotional and financial obligations associated with a funeral. The tax-exempt option was and remains the preferred choice for approximately 75% of preneed customers.

But as the MFDA statement suggests, consumers are better protected when annual statements are provided. In contrast to the old perception, regular contact between the funeral home and the consumer could be used to strengthen the consumer’s loyalty with the funeral home. Such contact could also help reduce another age-old preneed problem: but Mom said her preneed contract took care of everything.
 

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The Missouri Funeral Director and Embalmer Association provided crucial support to the passage of Senate Bill No. 1, but the heart of the association’s membership, the mom and pop operators, may now be second-guessing that decision.

SB1 provides regulators the authority to audit or examine preneed trusts and joint accounts, including those established prior to August 28, 2009. Missouri funeral directors are now hearing that the State Board will enforce provisions of the law against their old preneed business in such a way so to put their funeral establishment licenses at risk.

The State Board’s authority to audit preneed sellers under the old law was vague. During the 1980s and early 1990s, the State Board conducted ‘random’ audits. In reality, the audits were not random, but weighted by the number of contracts sold. Using independent CPA firms, audits were made of the same small group of sellers. The practice was challenged in the mid-1990s, and audits were discontinued.

While the vast majority of Missouri sellers have never been audited, their preneed contracts have been reviewed periodically by State Board inspectors. Funeral directors are now troubled by the prospect of those contracts failing to pass muster when reviewed by an independent CPA firm.

The licensees’ worries are well founded. Few funeral homes engaged legal counsel for the purpose of preparing preneed contracts or trust agreements. Instead, funeral homes shared or borrowed documents, often without regard to such specifics as how the contract was to be funded. Consequently, funeral homes have used trust-funded contracts for joint accounts.

Some funeral directors are bound to take a defiant position with the State Board’s enforcement of SB1 against their preneed paperwork. While it is predictable that the State Board may assert the licensee’s failure to engage legal counsel is no defense, licensees represented by counsel also have reason to be indignant with the Board.
 

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In May 2009, the American Funeral Director editorial advised that fixing preneed has to be a cooperative effort, and that the industry needs to agree upon a plan before attempting to legislate a fix. In that same month, the Missouri legislature passed a ‘fix’ to the NPS abuses that incorporated provisions from a mixed bag of industry recommendations. The Missouri funeral industry is now learning that their recommendations don’t amount to much of a plan.

With rumblings that Chapter 436 would have to be reopened this year to fix SB1’s flaws, the State Board took two important steps towards a plan: suspending any legislative efforts by state regulators for at least a year, and establishing a forum for industry attorneys to provide input regarding SB1. So now, in who’s court is the ball?

Mr. Defort suggests that state associations must take the lead in developing the “plan”. Perhaps, but that would depend upon the strength of the particular association’s membership. The Missouri Funeral Director and Embalmer Association played a crucial role in passing SB1, but the Missouri preneed industry is large and diverse. Consequently, the MFDEA cannot be expected to shoulder the plan-building task alone.

Some might suggest the ‘big’ sellers should step up, but the national companies have preneed programs that already comply with more stringent requirements than those imposed by SB1. The big sellers are waiting for the regulators to clarify SB1’s ambiguities and conflicts.

Rather, the ball would seem to be in the regulator’s court, and more specifically, the court of the Division of Professional Registration.

If the Division needs some starting points for a plan, here are four:

• Develop an annual reporting system that operators can use to demonstrate compliance with the 80% funding requirements of existing trusts (so as to minimize audit expenses and lower the $36 contract fee)
• Develop an alternative to the broken joint account contract
• Establish a voluntary compliance program to fix the technical violations that have accumulated over the past 27 years (when there were no guidelines or oversight)
• Establish a “no action letter” procedure that will allow more sophisticated sellers to determine the boundaries of compliance.

 

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The question isn’t whether preneed needs to change, but how to change it.

The November 2nd edition of the Funeral Insider highlights a new industry survey by Citrin Cooperman, a highly regarded accounting firm. The newsletter includes a section on preneed, and experts’ take on the survey. Their consensus is that preneed is broken. (Tell us something we didn’t already know!) But for the sake of giving sound bite advice, the experts compromise valid advice by resorting to generalities and false alarms.

The Citrin Cooperman survey is available for $295, a bit too rich for curiosity purposes. The accuracy of any survey is dependent upon sampling an appropriate representation of the population (in this case, the death care industry). What is lost by the FI critique of the guaranteed contract, is that applicable state law is the single greatest determinant of the structure of the preneed transaction.

Most of the country’s laws were written in response to the guaranteed contract, and do not contemplate any other form of preneed. If applicable law does not specifically authorize non-guaranteed preneed, most funeral directors will be reluctant to offer it. The availability of an alternative to the guaranteed contract is state specific, and therefore a survey limited to four states is of limited use to the remaining 92% of the nation.

With regard to the four survey states, it is worth noting that 8% of the respondents stopped offering the guaranteed contract during the past year. But does that mean 67% of the respondents are following the “wrong” strategy because they continue to offer a guarantee? Beyond state law, consumer expectations and/or competition dictate that a funeral home offer preneed, and then what form of preneed to offer. Most funeral homes are forced to respond to an evolving market, and the preneed resources available. It’s a business decision with many unique factors.

As the FI experts recommend, funeral homes need to pay more attention to their preneed program. But preneed isn’t an addictive drug, it is an option that consumers have come to expect. The problem with preneed is how the guarantee has been used to define the consumer’s expectations. But as funeral homes begin to limit their use of the guarantee and realign consumer’s expectations, preneed will become more complicated (and require more of the funeral director’s attention).

Consumers will still want to address the future costs of the funeral. If they are allowed to fund, but not purchase, how is the transaction to be regulated? Contrary to what one FI expert suggests, regulation of preneed has been based on a transaction involving the purchase of goods and services. Accordingly, many preneed sellers deem the payments as theirs upon receipt, even though those payments may be sitting in a trust, a bank account, or an insurance policy. This view of the transaction is supported by a series of position letters issued by the Securities Exchange Commission’ similar to the one issued to an Iowa preneed seller. The SEC wanted no part of regulating preneed.

As the industry moves to non-guaranteed preneed, or even partially guaranteed preneed, there will be a debate over who owns the trust funds, bank account or insurance policy: the consumer or the preneed seller. The answers will be more complicated, requiring more from our laws, regulators and the documents.

Too complicated for sound bite advice.

 

 

 

 

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With the upcoming new year, Illinois smaller funeral homes will begin searching for a corporate trustee for their preneed funds.  With the Legislature's approval of the Governor's Amendatory Veto of SB1682, funeral directors lose the authority to serve as fiduciary of their own preneed funds. 

 

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Like most states’ preneed laws, Missouri’s Chapter 436 has always contemplated a depository accounts for the small funeral operator who provides preneed as an accommodation. Many funeral homes do not sell enough preneed to warrant the expense and hassle of either a trust or an insurance license. Chapter 436 allows the funeral director to place 100% of the consumer’s funds into a joint depository account at a bank.

Despite certain glaring problems with the joint account contract, the Missouri legislature preserved the structure when it passed SB1, and re-wrote Chapter 436.

The small operator often accepts the consumer’s funds for purposes of a ‘spend down’ that will allow the consumer to exclude the funds from his/her resources for public assistance. Technically, the joint account requirements are not sufficient for excluding the funds, and funeral director is required to set up the account as “for the benefit of”. In doing so, the funeral director has not complied with Chapter 436 (old or new).

Because the transaction is an accommodation, the funeral director has little incentive to incur expense. Consequently, Missouri funeral directors ‘tend’ to borrow from each other with regard to documentation. While Chapter 436 has always required a contract form specific to joint account funding, antidotal evidence suggests many funeral directors borrowed a trust funded contract form for their joint account contracts.

SB1 requires the State Board to examine or audit all preneed sellers, including funeral homes that have joint accounts but decline to become licensed as sellers. This puts Missouri’s regulators in the difficult situation of citing small operators for Chapter 436 violations despite having all of the consumer’s funds in a depository account at the bank. For the integrity of preneed reform, the State Board cannot look the other way with regard to the joint account requirements.

Rather than force the small operator into either of the remaining SB1 options, Missouri should explore a new option for small operator.
 

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The old axiom was that it would take three consecutive legislative sessions to get a preneed bill passed. If Missouri and Illinois are indicators of the current preneed reform movement, the charm may be based not on attempts but actual bills passed by the legislature.

The Illinois Comptroller’s proposal for preneed reform, SB1682, is progressing quickly towards approval of the Governor’s amendatory veto. While the bill fails to address most of the recommendations made by the Governor’s task force, SB1682 will tighten the trusting requirements of preneed funds until comprehensive legislation is passed. Consequently, Illinois’ preneed sellers face the dual task of complying with SB1682 and negotiating the future of the preneed transaction. With the various pending lawsuits, the question is whether the Illinois death care industry has the capacity to work with regulators towards a consensus bill.

Missouri preneed funeral regulators have been slow to communicate the new requirements of that state’s new preneed law, Senate Bill No. 1. That bill was written without much cooperation from either the funeral industry or the cemetery industry, and the result is an ambiguous law that imposes requirements without sufficient consideration of practical compliance by the funeral industry. The law has been the source of tremendous confusion, and many funeral directors would rather ‘opt out’ completely. Against a backdrop of the NPS failure, regulators and funeral homes would be best served to reconcile their differences in an attempt to address SB1’s flaws.

Missouri’s cemetery industry also faces a similar legislative task. With a strategy based on the old axiom, one constituency of the Missouri cemetery industry pursued legislation that included provisions intended to provide preneed sellers an option out of SB1. That legislation included provisions objectionable to cemeteries with preneed programs, and most of the bill was scuttled at the 11th hour. The resulting bill opened the door for Missouri cemeteries to establish Chapter 214 preneed programs, but does not provide any regulatory oversight for consumer protections. The bill also leaves the Missouri cemetery industry with the prospect of being regulated under SB1.

Historically, it was the internal industry disputes that made preneed legislation so difficult to pass. Legislators would send the squabbling parties home until they could resolve their disputes. What has changed in the dynamics of preneed legislation is the role of the regulator. Frauds measured by the millions are forcing regulators to share in the accountability of preneed failures. The regulator’s agenda is now trumping the industry’s internal disputes in Illinois and Missouri.

But, the regulator’s trump card does not necessarily guaranty a law that best serves the consumers’ interests.
 

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The funeral director’s decision about how to fund his preneed is influenced by the state’s trusting requirement, investment returns, administrative convenience and the volume of preneed business. Essentially, there are three methods of funding preneed: the depository account, the master trust and the insurance policy.

The funeral director’s use of the depository account predates all state preneed laws. The industry has been accommodating families for decades by accepting payment for a future funeral, and then placing those funds in an account at the local bank. The early preneed laws reflected this practice with language that sought to impose how the depository account was to be structured. Those early laws gave rise to the “joint account contract”.

By the 1970s, proactive preneed sales organizations were testing the limits of the depository account. Low returns and administrative hassles caused the proactive seller to abandon depository accounts in favor of insurance or master trusts. For states with high trusting requirements, the proactive seller turned to insurance funding because it provided the commissions required to pay salesmen and finance the preneed program. In states with a lower trusting percentage, the master trust provided the seller the economies of scale to achieve higher returns and lower administrative costs. But, the master trust’s popularity was stunted by Revenue Ruling 87-127.

With preneed insurance carriers now cutting policy benefits, some funeral directors will need to reexamine the master trust, and the use of finance charges.

Generally, the purchase price of a guaranteed preneed contract is set by the funeral home’s general price list (the prices it charges for a funeral that would be performed today). In today’s economy, fewer consumers can afford to pay for a preneed contract with a single payment. But when a family is permitted to pay for the preneed contract over a period of five to ten years, the cost of the funeral at the contract’s performance will often exceed the trust proceeds by thousands of dollars. Regulators assume that the trust’s income will offset or exceed the rise in the costs of the funeral, but that is seldom the case with contracts paid by installments. These contracts often representa loss to the funeral home.

Some funeral homes already include finance charges in their installment payments to offset the loss of trust earnings. However, funeral homes have not been consistent in their disclosure of the finance charges. In fact, NPS was notorious for incorporating a 12% administration charge into an installment schedule that also included a mortality charge. None of which was disclosed to the consumer.

As reflected by a Kansas Attorney General’s opinion, regulators often perceive that finance charges are an exploitation of the consumer. Instead, regulators should ensure that finance charges (or administrative charges) are adequately disclosed to the consumer, and reasonable to both the consumer and the seller.
 

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The emergency rule that implements Missouri’s $36 per contract fee becomes ‘official’ on October 4th.  Missouri funeral directors question whether the fee is too high, and whether it will contribute to the decline in preneed sales. The analysis required for the emergency rule reports that the fee is expected to generate $612,000 of revenues that will be used by the State Board of Embalmers and Funeral Directors for the enforcement of Senate Bill. No. 1. While funeral directors will challenge the State Board’s need for $612,000, the industry must consider how a few problem sellers contribute to the cost of preneed.

The State Board’s October 20th agenda includes a disciplinary hearing on a preneed seller involving allegations of multiple violations. The administrative order included with the agenda reflects extensive time and effort expended by the Board’s staff, investigators and attorneys. The alleged misconduct covers several years and several preneed purchasers, and the proceeding represents a substantial cost to the State Board.

Missouri has never had an effective preneed exam or audit program.  Consequently, regulators are left to question whether the October 20th hearing is just the tip of the iceberg.

Sellers with a compliant preneed program question why a few bad apples should spoil the barrel for the entire industry. With the $36 fee providing the Board most of its funding for audits and enforcement proceedings, compliant sellers have a reasonable argument that the fee represents an inequitable surcharge to their families. But, Missouri’s sellers face an up hill climb in any fight for a lower fee.

The climb up that hill begins with two proposals: better annual reporting and a shift of audit expenses.

With better annual reporting, Missouri’s regulators could spot trouble accounts without an audit, and when less drastic enforcement actions are an option.

When the State Board’s preneed examination discloses material non-compliance, the costs of an audit and enforcement proceedings should then be borne by the seller.

 

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Over the past few years, preneed frauds have been measured in terms of hundreds of millions (with the suggestion that the NPS loss will top a billion).  And, funeral directors and consumers have been frustrated by the perception that regulators are helpless to stop preneed fraud.  Apparently, one local prosecutor from Texas took notice.

When the Texas preneed regulator and Attorney General failed to address an $8,000 fraud, the Galveston County prosecutor obtained a grand jury indictment against a Texas funeral director for the misappropriation of preneed funds.  Generally, the prosecution of preneed fraud falls to the death care regulator and/or the state attorney general.  Realizing that state coffers may be lean for years to come, legislatures such as Missouri's are granting local prosecutors concurrent jurisdiction to prosecute preneed law violations. 

The prospect of prosecution by a district attorney with no prior experience interpreting an ambiguous preneed statute was sufficient reason for funeral directors to oppose legislation that authorized concurrent jurisdiction.  However, circumstances such as those in Missouri and Illinois have opened the door for comprehensive reform legislation, and concurrent jurisdiction. 

When the attorney general may lack the resources to prosecute an $8,000 preneed fraud, the local prosecutor, looking to make a name for himself/herself, can initiate a prosecution of the wayward funeral director by using statutes such as Missouri's Chapter 436. 

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The Missouri State Board of Embalmers and Funeral Directors faces two hurdles to implementing SB1: disagreements over the interpretation of key provisions and informing the industry how the Board will enforce the law. These hurdles have put the Board in to a Catch 22 situation.

SB1 was drafted under the cloud of the NPS crisis. Legislators were lobbied from all sides, with positions as diametrically opposed as outlawing preneed to leaving Chapter 436 in tact. With limited assistance from the industry, legislators used the resources at hand and forged compromises. As a consequence, the law has several ambiguities, and crucial provisions can legitimately be interpreted differently. There is ample room for disagreements.

The disagreements over SB1 requirements have caused the State Board to reconsider how to best educate the industry. When contacted with SB1 questions, the Board’s staff (and website) recommends that licensees seek the advice of an attorney. This may be the appropriate ‘legal’ answer, but it is one that will frustrate the licensee. First, the advice requires the licensee to incur an expense at a time when it can be least afforded. Second, there is no assurance an attorney can provide an answer the licensee can rely upon. Some attorneys will turn to the Board’s legal staff, and it is not clear those attorneys are in a position to field questions about SB1.

As licensees, funeral directors do have a responsibility to educate themselves about the law’s requirements. We have heard this at recent Board meetings. But, before the licensee can educate himself on the law’s requirements, the State Board must be able to clearly articulate the law’s requirements. That could require weeks on most issues, if not months on other issues.
 

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The September edition of the Mortuary Management ran an excerpt from a Funeral Monitor article about the California Master Trust suffering a deficit. 

If the story is accurate about the master trust's shortage, the author's speculation about the reasons for the deficit omits a possible factor that has existed for years: the 4% administration fee. 

As explained by the Cemetery and Funeral Bureau's audit guide, California law allows for an annual 4% administration fee.  If the CMT takes the full administration fee allowed by law, no wonder the trust is running a bit short.

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One criticism of Missouri’s prior preneed law was that the Attorney General’s office was dependent upon the State Board to refer complaints for legal enforcement. If the State Board didn’t refer a Chapter 436 violation, the AG’s only enforcement alternative was to pursue an action under Missouri’s Merchandising Practices Act (Chapter 407). During the 2008 hearings on Chapter 436 and National Prearranged Services, it was generally recognized that the Attorney General’s office needed independent authorities to pursue Chapter 436 violations. But, the Attorney General also expressed the desire for authority to hold fiduciaries more accountable for their funeral home client’s actions.

The AG’s fiduciary recommendations drew concerns from both funeral homes and the Missouri Division of Finance. The Division of Finance questioned whether the requested powers would make the AG a de facto bank regulator on par with the Division and the bank’s federal regulators. Consequently, the final recommendations for Chapter 436 legislation conditioned the AG’s authority to take action against a fiduciary on having received the consent of the fiduciary’s primary regulator.

However, the Chapter 436 Working Group recommendation regarding this limitation on the Missouri Attorney General did not survive the Senate Bill No. 1 revision process.

Section 436.470.12 of SB1 grants the Attorney General the authority to bring action against a preneed fiduciary whenever an “inspection, investigation, examination or audit” reveals a violation of Chapter 436. A prior subsection provides for information sharing among the relevant Missouri agencies, and arguably, the AG’s authority over preneed fiduciaries could be triggered by the AG’s own investigation or examination.

And, there seems little doubt that the AG may be inclined to apply this new authority with regard to preneed trusts that existed prior to August 28th. Accordingly, Missouri’s preneed fiduciaries should evaluate their accounts with the knowledge that Big Brother may be looking.
 

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The first week under the new preneed law was a confusing one for the Missouri funeral industry. SB1 has many drafting conflicts and ambiguities, and that has give rise to different interpretations from the Attorney General’s Office, the State Board of Embalmers and Funeral Directors, and the death care industry.

The State Board and the Attorney General’s Office have been criticized for the NPS debacle. While some of that criticism may be justified, NPS exploited the weaknesses of Chapter 436 (and the Board’s enforcement budget), and kept the regulators at bay for years. With SB1, the regulators have been given the keys to a new vehicle for preneed oversight and enforcement, but they are not in total agreement about the map to follow.

The State Board’s immediate agenda are the emergency rules that will keep the preneed industry functioning for the next 3 to 9 months. Consequently, debate over interpretations must be brief and concessions must be made. In some respects, the resulting emergency rules will be overly burdensome. But, these emergency rules will be the law until regulations are promulgated pursuant to the normal rulemaking process. Funeral homes that disregard the emergency rules, do so at substantial risks. It is crucial that funeral directors also understand that the emergency rules will impact the preneed contracts sold prior to August 28th.
 

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As its first step in educating the preneed industry about SB1’s requirements, the Missouri State Board of Embalmers and Funeral Directors posted the Top 12 Changes to Missouri’s Pre-Need Law to its website. However, I had trouble getting past No. 2. The explanation about fiduciary reimbursements of sales expense on Pre-SB1 sales sent me back to SB1’s ‘Grandfather clause’:

436.412. Each preneed contract made before August 28, 2009, and all payments and disbursements under such contract shall continue to be governed by this chapter as the chapter existed at the time the contract was made.

As authorized by RSMo. Section 436.027, it has been fairly standard practice for Missouri preneed contracts to recite that Sellers may retain the first 20% of the purchaser’s payments. However, the State Board is advising all Purchaser payments, including PreSB1 business, must be deposited to trust before the 20% sales expense is retained.

While the State Board’s intent may have been to address the old statute’s failure to address when purchaser payments must be deposited to trust, the Board has overstepped its authority if its intent is to require sellers to deposit payments on PreSB1 contracts to trust without retaining sales expense.

 

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Reform in Illinois inched closer to reality with Governor Quinn's "amendatory veto" of SB1682.  If accepted by the Illinois legislature, the reform bill will become law on January 31, 2010.

However, the Governor is seeking a 30 day window between the deadline for the report due from the Funeral Burial Task Force and SB1682's effective date.  It is doubtful much could be done to change SB1682 during that 30 day period.  Accordingly, the Governor's action adds confusion for the Illinois death care industry.  

If the amendatory veto is approved, Illinois funeral homes and cemeteries should plan for the January 31, 2010 effective date.    

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The Missouri State Board of Embalmers and Funeral Directors meets August 25th to vote on emergency rules that are intended to keep the preneed industry functioning when SB1 goes into effect on August 28th. While numerous issues have been identified to the State Board as deserving of emergency status, four stand out above the rest: licenses, the new trusting of all payments, preneed contract requirements and the cemetery exemptions.

To sell preneed after Thursday, funeral homes must have a license. It doesn’t matter whether the funeral home is offering joint account contracts, trust-funded contracts or insurance-funded contracts, a seller license is required. The same is true if the funeral home intends to honor a preneed contract sold after Thursday. A preneed provider license is required. A preneed agent registration will also be needed for each individual that sells a preneed contract.

But, the State Board does not have the authority to issue a license until Friday. So, the State Board will vote on a special form called the Notice of Intent to Apply for Licensure/Registration that will be used for both licenses and the preneed agent registration.

Once the form is approved, the State Board will place it on their website for downloading. Applicants should consider executing the form in duplicate.

Completed copies of the form could be emailed (in a PDF format) or faxed to the State Board (save the transmission as evidence of the filing). An original copy will have to be mailed to the State Board. The other original copy should then be posted where the funeral home would normally display its establishment license.

It will be near to impossible for preneed sellers to establish new trusts in time for business written after Thursday. Accordingly, the State Board will consider whether to allow newly ‘licensed’ sellers to establish an account with a bank for use as a clearing account for purchaser payments on contracts sold after August 27th.

The new law also will require changes in the preneed contracts sold after Thursday. Most of the Missouri preneed industry utilizes printed contract forms that can take weeks to prepare. Consequently, the State Board is considering a rule to permit continued use of those old contract forms.

Finally, Missouri’s cemeteries are waiting to hear the State Board’s interpretation of the cemetery exemptions from licensing and Chapter 436 compliance. Cemeteries will have their own licensing and trusting requirements under Missouri’s Chapter 214.
 

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Come August 28th, every Missouri funeral home that plans to sell or honor a preneed contract must file a Notice of Intent To Apply. The State Board of Embalmers and Funeral Directors has devised this form to ease the rush that will occur when hundreds of licenses must be obtained. However, many Missouri funeral homes are under the mistaken belief they already possess licenses as preneed sellers and providers.

There is a document hanging on many funeral homes’ wall that indicates the entity is authorized as a “Preneed Seller” or “Preneed Provider”. The document also references an “Original Certificate/License No.” However, those documents are verification of the entity’s compliance with ‘old’ Chapter 436’s registration requirements. The “new” Chapter 436 imposes a license requirement. Come August 28th, those registration certificates are only worth the paper they are printed on.

In contrast to the Mexican bandit in The Treasure of The Sierra Madre, Missouri funeral homes do need a filed Notice of Intent to sell/honor preneed after August 28th. The State Board has published its draft of an emergency rule addressing the Notice of Intent.
 

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Recent cemetery failures are causing regulators from Illinois, Missouri and Kansas to take a closer look at the oversight provided for preneed sales of vaults, markers, urns and burial services.

Cemetery preneed is a different animal for that offered by funeral homes. As Mr. Newcomer suggested to a reporter, the big difference between the two industries revolves around the grave. The interment represents a perpetual obligation on the part of the cemetery.

For the cemetery, the preneed sale typically begins with the grave sale. For the larger cemetery, the preneed sale seldom ends there. The cemetery may sell a variety of merchandise and services to lot owners. Many of the items can be delivered in advance of death, but often the lot owner will want to defer delivery of some of the items.

In contrast to a funeral, cemetery preneed can not be tied to a death, and as a consequence, life insurance is not a viable funding vehicle. Trusts or constructive delivery are the main methods of safeguarding the consumer.

When trust funded preneed is used by the cemetery, the preneed accounting involves a ‘bucket’ for each category of merchandise or service offered to the consumer. Cemetery preneed sales are often made in stages, with the consumer adding items as his/her budget allows. Consequently, buckets are added or emptied as the consumer adds purchases or consents to the delivery of merchandise (like a marker).

As regulators look to provide more oversight to the cemetery preneed transaction, they need to understand the bucket factor.
 

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News of Randy Sutton’s arrest was greeted by honking hearses in Missouri, Texas, Illinois, and a dozen or so other states. But, the question funeral directors are asking: What about the Cassity family?

Federal investigators need for someone to rollover and give up the Cassity crew, and apparently, Mr. Sutton is their choice.

Matt Damon’s new movie, the Informant will be out soon. That movie is about Archie Daniels Midland, a mega-food conglomerate based in Decatur, Illinois, my old hometown. Part of the movie was shot in the little town of Moweaqua, where my wife’s family lives. For weeks, we received photos of Matt Damon obliging the local residents. The story is about an ADM executive who turned informant on his employer’s misdeeds, but took a fall due to his own conduct.

As the Feds put the screws to Mr. Sutton, funeral directors can only hope those investigators can connect the dots. If they do, and the Cassity family is implicated, who will play Mr. Sutton in the movie?
 

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Missouri’s Chapter 436 reform law goes into effect on August 28th, and the Missouri State Board of Embalmers and Funeral Directors will have the responsibility of implementing the new changes. However, the State Board is caught in a Catch 22 situation.

Many of the changes will have to be implemented through regulations, but the Board doesn’t have Chapter 436 rulemaking authority until August 28th. For example, preneed sellers and providers will have to be licensed on August 28th . Since this is a new requirement, every preneed seller in the state will have to file an application and fee to be licensed. There are hundreds of funeral homes that will seek a seller’s license, and not a one can sell a preneed contract until the license is in hand. But, the Board can’t begin passing regulations about the licenses until August 28th. To avoid a shutdown of the preneed industry, the State Board will have to improvise through the use of emergency regulations and temporary licenses.

Accordingly, the State Board will be meeting every week during the month of August to establish its priorities for Chapter 436 regulations. The Board’s agenda for those meetings are set out on its website.

The State Board is seeking input from funeral directors in the form of written questions or comments regarding the agenda issues. By seeking comments in advance of publishing proposed rules, the State Board is hoping to expedite the regulation approval process.

Historically, some Chapter 333 rules have taken up a year or more to pass. The rulemaking process requires a Board meeting to discuss the issue and direct the legal staff to draft a proposal. Then a few months later at the next meeting, the Board will consider the proposal, and if acceptable, submit the proposal to the Secretary of State’s office for the publication process. With the publication, there is a comment period. Then, the comments are discussed at the next scheduled Board meeting. Depending upon the comments, the proposal may be revised, and if so, there will be another publication and comment period. All in all, the rulemaking process can be lengthy.

In the meantime, the Missouri preneed industry is waiting on the Board for directions on such issues as contract disclosures and trust administration requirements.

Missouri is in for a long, painstaking period of change.
 

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My kids hate August because it means its time to head back to school.  This year's student population in Missouri will be a little larger than last year's.  The Missouri State Board of Embalmers and Funeral Directors has released its meeting agenda, and the state's preneed industry will be given four crash courses beginning July 30th. 

Generally, freshman orientation is optional, but these classes may start defining a new business model for Missouri's preneed industry.

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Governor Nixon signed Senate Bill No. 1 on July 16th, giving Missouri preneed sellers six weeks to prepare for Chapter 436’s new requirements. For trust-funded contracts, one of those requirements will be the deposit of all preneed payments to trust. Section 436.430.2 provides in part:

A seller must deposit all payments received on a preneed contract into the designated preneed trust within sixty days of receipt of the funds by the seller, the preneed sales agent or designee.

Under the current law, sellers could retain the first 20% of the purchaser’s payments before making a deposit to the trust. While the new law will permit the seller to recover an origination fee of 5% and another 10%, the seller must make a request from the trustee to receive such amounts. The purpose of this requirement is to establish an audit trail of all consumer payments. As reported recently by an Ohio newspaper, Missouri is not alone in its efforts to make operators more accountable.
 

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The New York Department of Motor Vehicles warns its citizens to plan ahead when it comes to obtaining or renewing their driver’s license. The busiest days of the month are the first and last days of the month. The first day of the month is busy from those who want to beat the rush or who just realized their license expired during the prior month. Then there are the procrastinators who put off the renewal until the very last day.

The New York DMV also warns its licensed drivers to reconsider any plan of completing the renewal process over their lunch hour. The message to drivers (and hopeful 16 year-olds) is to plan ahead because the process will take as long as required to ensure the license is properly issued. It is easier for a licensing authority to say ‘no’ than it is to take the license away once it has been issued.

Missouri funeral homes will face a licensing bottleneck of their own when Senate Bill No. 1 becomes effective August 28th. For the first time, the State Board of Embalmers and Funeral Directors will be licensing hundreds of preneed sellers and providers.

Although Missouri funeral homes may be registered as preneed sellers or providers, the ground rules have changed drastically under Senate Bill No.1. Accordingly, an early decision the State Board will have to make under the new law will regard how to screen seller and provider license applications.

To avoid disruptions to operators’ preneed programs, the State Board may need to consider issuing provisional licenses that assure compliance with the fundamental requirements of Senate Bill No. 1.
 

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For twenty-five years, Missouri funeral directors have had it easy with regard to accounting for consumers’ preneed payments. Chapter 436 required the preneed seller to maintain 80% of the preneed contract sales price in trust. The Missouri law also allowed the preneed seller to withdraw income so long as the 80% threshold was maintained. Consequently, the seller’s trust accounting was fairly simple. However, Senate Bill No.1 has rewritten Chapter 436, and in doing so, will impose a substantial change of accounting upon the Missouri preneed industry.

To establish an audit trail, SB1 requires every payment made on a trust-funded contract to be deposited with the fiduciary institution. The law will also require the preneed trust to accrue income, which the consumer may transfer to an alternative funeral provider. Consumers can also request account information. All of this will require the preneed fiduciary to make monthly allocations to the trust’s individual preneed accounts.

To an extent, the new accounting requirements will also be incorporated into annual regulatory reports required of preneed sellers.

A new era of accountability begins in Missouri.
 

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A little more than a month has lapsed since the Missouri legislature passed a reform preneed bill, but the death care industry remains stuck in neutral until Governor Nixon signs SB1 into law. 

With an effective date of August 28th looming two months away, regulators and funeral homes (and cemeteries) face licensing and document deadlines.  The State Board of Embalmers and Funeral Directors will have the task of licensing hundreds of preneed sellers and providers.  Preneed sellers will have the task of establishing new trusts and preneed contracts. 

This should make for a busy Show Me summer.

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Federal and state regulators can not quite agree on how to define the preneed transaction.  Federal regulators tend to view the preneed transaction as a current sale of goods and services (where the delivery is deferred until a future date).  In contrast, state regulators are increasingly defining the transaction in terms that defer consummation of the sale until the beneficiary's death.   This is reflected in a bill (SB1682) passed recently by the Illinois Legislature.

Through a deletion to 225 ILCS 45/1b (b), the preneed seller will no longer be allowed to retain a finance charge from the purchaser payments.  While not all preneed sellers include a finance charge on their installment sales, some do in order to offset the earnings lost when the purchase is paid over time.   

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When Missouri’s Chapter 436/NPS reform legislation began to take shape last summer, the state’s cemetery industry sought to get out of the train’s way by incorporating new preneed provisions into a Chapter 214 bill. To clarify that cemeteries could establish preneed programs that would be regulated exclusively under Chapter 214, and not Chapter 436, statutory exceptions were drafted into Senate Bill 1 not once, but twice. To add a belt to those suspenders, a statutory exception for cemeteries was also drafted into the Chapter 214 bill. But alas, there has been a small slip between the cusp and the lips.

SB1’s two ‘cemetery exemptions’ are found at Section 333.310 and Section 436.410. Section 333.310 was intended to exempt cemeteries from the State Funeral Board jurisdiction and Section 436.410 was intended to exempt cemeteries from Chapter 436.

333.310 The provisions of sections 333.310 to 333.340 shall not apply to a cemetery operator who sells contracts or arrangements for services for which payments received by, or on behalf of, the purchaser are required to be placed in an endowed care fund or for which a deposit into a segregated account is required under chapter 214, RSMo; provided that a cemetery operator shall comply with sections 333.310 to 333.340 if the contract or arrangement sold by the operator includes services that may only be provided by a licensed funeral director or embalmer.

436.410. The provisions of sections 436.400 to 436.520 shall not apply to any contract or other arrangement sold by a cemetery operator for which payments received by or on behalf of the purchaser are required to be placed in an endowed care fund or for which a deposit into a segregated account is required under chapter 214, RSMo; provided that a cemetery operator shall comply with sections 436.400 to 436.520 if the contract or arrangement sold by the operator includes services that may only be provided by a licensed funeral director or embalmer.

Both exemptions define a cemetery preneed arrangement where the purchaser’s payments must be deposited to an endowed care fund or a segregated account. One problem with this is that endowed care trusts cannot be used for preneed payments. A second problem is that the segregated account arrangement was eliminated from the final version of SB296. The Missouri cemetery industry’s last chance for a statutory exemption, a new Section 214.320.5, fell victim to a last minute deletion from SB296.

Missouri cemeteries now face an uncertain future with a new Chapter 436, and an expanded Chapter 333.

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Finding a fiduciary institution that is both knowledgeable and receptive has proven a challenge to funeral directors. Until a few years ago, the larger operators could rely upon the size of their trust to at least generate interest from prospective institutions. However, litigation exposures are now causing institutions to hesitate with even the largest of trusts, and the Illinois Comptroller’s proposed legislation would raise the fiduciary bar even higher for Illinois funeral homes.

If given the choice, state preneed regulators prefer that sellers use a ‘domiciled’ fiduciary institution. It is easier to hold domiciled institutions accountable under the preneed law. However, the preneed regulator’s jurisdiction begins to ‘cloud’ with regard to a foreign state-chartered institution, or a federally chartered institution that is not “located” within the state.

The Illinois Funeral or Burial Funds Act, like other states’ preneed laws, has an ambiguity that opens a ‘back’ door for foreign fiduciaries. While paragraph (b) of Section 225 ILCS 45/2 contains language stating the preneed fiduciary is to be domiciled in Illinois, paragraph (f) authorizes the use of foreign fiduciaries without the institution subjecting itself to the jurisdiction of state regulators. The Comptroller is now looking to close that ‘back’ door by deleting paragraph (f). The consequence to the Comptroller’s proposal would be to require the foreign fiduciary to comply with the Illinois Corporate Fiduciary Act.

Each state has a law governing the fiduciary activities of foreign institutions, and some are more liberal than others. State chartered institutions have no choice but to comply with these laws if it is deemed that the fiduciary services are being rendered within the state. In contrast, OCC and OTS chartered institutions will generally assert federal preemption arguments. With regard to both state chartered and federally chartered institutions, the language of the preneed law and the preneed contract are relevant to the issue.

The Texas Department of Banking addressed these issues in a 2001 opinion, with a compromise of sorts. In reaching that opinion, the Texas attorneys were mindful of the 1998 OTS opinion obtained by Forethought Financial Services. While on its face, the OTS opinion reads as a “Pass Go” and Collect $200 card, certain representative facts undermine the opinion’s value. State preneed regulators will invariably dispute the facts asserted by the “Association” at the bottom of page 7 of the opinion.

Following the Texas lead, state preneed regulators need to be flexible with foreign fiduciaries willing to comply with their state’s preneed law without ‘locating’ within the state.

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At the risk of plagiarizing the Missouri Funeral Directors and Embalmers Association, Missouri preneed funeral sellers, providers, fiduciaries and insurers face a new ballgame that will begin August 29th without a complete set of rules and guidelines. Funeral directors have a general idea where the game will be played, but they’re not quite sure what rules the umpires will use or how closely the game will be called.

In contrast, Missouri’s cemetery industry has been left to guess where their game will be played. Through last minute changes, the cemetery bill was pared back to those essential provisions required to authorize trust-funded preneed sales and a fixed-distribution provision for endowed care trusts. The resulting provisions do not begin to tell the underlying issues.

Funeral directors get the first crack at learning their new ‘rules’ on May 28th when the MFDEA sponsors a session with the Chapter 436 umpires. Based on the success of that session, one of the 436 umpires (the State Board) will probably explore regional meetings with funeral homes.

In the meantime, Missouri’s cemeteries will need to regroup in an effort to work out a consensus on preneed and endowed care legislation.

For a copy of the changes to Chapter 436 click here, and for Chapter 214 changes click here.

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The battle to reform Illinois’ preneed funeral law was renewed by the Comptroller’s office with the release of his Amendment to Senate Bill 1862. Reform in Illinois will take months, and the final product may differ substantially from the Comptroller’s proposal. However, SB 1862 flags Mr. Hynes’ priorities, and one of those priorities could force a shotgun marriage between the IFDA and some of the small funeral homes critical of the Association.

The Illinois preneed law authorizes a preneed seller to act as its own trustee when the seller’s preneed funds are less than $500,000. This provision is a reflection of the difficulty and expense encountered by small operators attempting to find affordable trust services. However, the IFDA exploited this provision with regard to its master trust, and consequently, the Comptroller wants to eliminate the self-trusted arrangement.

The advantage of an association master trust is that it provides the requisite economies of scale to provide affordable trust administration to the smallest funeral home operator. But, many Illinois operators shunned the IFDA master trust because of a lack of transparency. The amount of preneed funds held in self-trusted arrangements could be substantial. If the Comptroller seeks to apply the elimination of the self-trusted exception retroactively to existing trusts, the cost of corporate fiduciary services and the scarcity of such fiduciaries may lead these operators back to the IFDA, perhaps with the numbers to force changes at the Association.

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The New York preneed law may be the best consumer oriented preneed law in the country (see Page 47 of the AARP Survey). It requires 100% trusting, the accrual of income and limits the permissible investments. The New York State Funeral Directors Association has good reason to be proud of their preneed program. Yes, their preneed trust is safe and steady. But, it is a one-of-a-kind model that owes a certain amount of its success to New York’s restrictions on insurance funding.

The bar set by the NYSFDA for other state associations is impossible to obtain in today’s legal environment. The last sentence from a recent article about the IFDA’s woes is most telling:

“The only lobbying we’ve had against our laws is from the insurance industry, which would like to bring their products into New York.”

Other than New York, what states prohibit insurance funded preneed contracts? States that consider the New York standards without insurance funding restrictions need to examine the consequences to the consumer and to the funeral home operator. If trusting requirements are set too high, operators will resort to insurance funding for their preneed contracts. Funeral directors will have insurance licensing requirements to fulfill, and consumers will have fewer preneed options.

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Like the Swine Flu, a preneed virus has been spreading across the Midwest.   Looking for a cure, state legislators and regulators have been forming research teams.  It all started last summer, with Missouri’s Chapter 436 (funeral) working group and Chapter 214 (cemetery) working group.  Now, Illinois is establishing a preneed task force, and Kansas is forming a cemetery committee.  But, in contrast to the Missouri Chapter 436 working group, the forthcoming preneed research teams are limiting the industry’s involvement in the proceedings.  It’s not that the patient has a terminal condition that is contagious, but rather a reflection that organizing industry participation can be akin to herding cats.

Take the May edition of the American Funeral Director as an example. There are no less than six articles addressing preneed. As Mr. Creedy points out, everyone in the industry has an opinion and some can’t help but apply a general prescription for the preneed transaction. But, preneed is governed by more than 50 different state laws, making the transaction impervious to such generalizations. Boiling the issues down for the sake of an editor’s guidelines only contributes to the confusion of our industry members. While these types of articles often quote experts with opposing (and often, valid) opinions, death care operators tend to remember only the opinions that support their preneed program (or, supports their opposition to another form of preneed).

The preneed problem involves complex issues that require an in-depth analysis by our respective state legislators and regulators. For the sake of our consumers, we need to provide legislators and regulators objective and unbiased information about all aspects of preneed.

This patient is very ill, but not terminal. There are no easy cures or solutions.

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Missouri’s preneed reform legislation will be amended on the House floor in the next day or so, and some of the Representatives have heard that old phrase about legislating morality. There is some truth to that phrase, and to some of the other objections raised against the reform legislation.

Preneed oversight will impose a substantial financial burden on a strapped state government and regulators lack the requisite experience to define the future course of preneed. However, these objections seem to wither when read in conjunction with the ‘excuses’ of the IFDA member funeral homes.

In a nutshell, Illinois funeral directors did not perform due diligence with regard to the management of their master trust. Instead, funeral directors placed their trust in their elected leadership, who then placed their trust in an investment advisor.

For those of us who work in this industry there is one given fact: funeral directors are caregivers by nature, and would rather spend their time with a family than the preneed trust’s accountant, attorney and investment manager. Well respected industry leaders are calling the current preneed situation “nuts”, and recommend that funeral directors focus on what they do best: serve the family. This advice resonates with most funeral directors, but they also know that families have come to expect the preneed option. But if preneed is to be offered, funeral directors must begin doing their homework.

Two years ago, Sue Simon wrote about Missouri’s triple-dipping trusts. One might have thought NPS’ demise brought this issue to an end, but that is not the case. A program utilizing a variable annuity product is being marketed to Missouri funeral directors. The promises made with regard to this product seem familiar to those made to the IFDA.

Depending on the final version of Missouri’s preneed reform legislation, funeral directors and fiduciaries may be forced to explain the condition of their preneed trusts. It would be best to put the Illinois Secretary of State’s questions to the investment advisor before the investment is made, rather than after.

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Many preneed trusts either experienced significant capital losses last year or are sitting on assets that have unrealized losses. For those trusts that have taken a Section 685 election, these losses may be carried into future years as a capital loss carryover. While everyone would prefer to avoid realizing those losses, that loss can be used to offset future trust income. With the proper individual contract accounting, the loss could be extended for a longer period than the aggregate reporting followed by many trustees. For an explanation of Section 685 and the differences between aggregate reporting and composite reporting see our August 9, 2008 post titled “The Section 685 QFT amendment: Supporting Soldiers’ Survivors”.

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As new allegations surface about the Merrill Lynch broker associated with the IFDA master trust, some may appropriately ask why a preneed trust would ever invest in an insurance product. There was a time when the twain shall never meet. That all changed in January 1988, and specifically when the IRS and Treasury decided to apply Rev. Rul. 87-127 retroactively to states ‘that should have known’ the funeral home/grantor method of income reporting was inappropriate.

Prior to the ruling, preneed trustees were taking different approaches to reporting the income earned by the trust. With regard to states such as California and Illinois, the trust was required to accrue income and the Service believed trusts from those states lacked authority for electing the grantor method with the preneed seller as grantor.

Consequently, the Service leveled the boom by serving notice that the ruling would be applied retroactively in certain states. This posed a genuine problem for existing trusts because most lacked the requisite consumer information to report income in compliance with the ruling. Thus started a mad scramble to find an alternative to income reporting, and thus began the exodus to insurance.

Today, preneed trustees can avoid the burden of Rev. Rul. 87-127 by electing taxation pursuant to IRC Section 685. While a few legitimate reasons for preneed trusts to hold an insurance product remain, the insurance transaction merits close scrutiny, particularly when a conversion of existing assets to insurance is involved (NPS and its Missouri trusts).

The preneed trustee should ask certain fundamental questions of those who seek to have the trust invest in insurance:

· How will this product be taxed upon maturity?
· Does this product provide the requisite liquidity to fund cancellations?
· Is a commission paid, and to whom?
· How strong is the policy’s issuer?
 

To the extent a life insurance policy is utilized, the decision invariably becomes an irrevocable election. The policy’s cash value generally precludes getting back out.

Generally, annuities provide a more flexible alternative to life insurance, but pitfalls still exist. In recent years, funeral directors have received solicitations to have their preneed trusts invest in a group, variable annuity product. Trustees still need to ask these fundamental questions, particularly when an investment broker is advising the funeral director.

With regard to the taxation of the insurance product, few seem to realize that the trust is dependent upon Rev. Rul. 87-127 for the desired tax consequence.

For those interested in the history of Rev. Rul. 87-127, and its alternative reporting method (Section 685), Professor Joel Newman provided a fair and accurate account in 80 Tax Notes 711.

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With a recent editorial opinion, the State Journal-Register seeks to keep U.S. Senator Roland Burris accountable for his role in the IFDA master trust problems by asking the following questions:

· As comptroller, why did he think it was a good idea to allow the IFDA control of the fund?
· How did he monitor the group?
· Did he ask questions about its administration?
· Did he know that it would be backed by life insurance policies on IFDA leaders and members?
· When he became a lobbyist for the IFDA in 2007, what solutions did he envision?

But in the effort to build a fire under the Senator’s feet, the paper may have innocently misstated the facts.

What little that has been released about the master trust’s current state does not suggest that its value has dwindled down to $59 million dollars. While the fund has undoubtedly lost value, some of the ‘write down’ numbers attributed to the master trust represent an accounting change in what is to be paid funeral homes.

However, this should not detract from the paper’s effort to hold Mr. Burris accountable for his role in the IFDA’s problems.

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While the settlement negotiated with the National Organization of Life and Health Insurance Guaranty Associations (“NOLHGA”) provides funding for the vast majority of NPS preneed contracts, there could be as many as 7,500 NPS preneed contracts that fall outside this coverage. For one of a couple of reasons, NPS never purchased an insurance policy for these preneed contracts. These are the NPS “orphan contracts” that regulators and the NPS Special Deputy must figure out what to do with.

NPS and its sister insurance companies were put into receivership by the Texas Department of Insurance. The special deputy receiver appointed to administer the NPS assets and liabilities negotiated coverage with the National Organization of Life and Health Guaranty Associations (NOLHGA). However, this coverage is dependent upon a policy (or sufficient evidence of the intent to purchase a policy) having been issued for the consumer’s preneed contract. In the absence of a policy, the guaranty association will not honor a claim, and the consumer will be forced to make a claim with the special deputy receiver.

The orphan contract is primarily a Missouri problem because NPS sold insurance funded preneed contracts in most states. For Missouri, NPS sold trust-funded contracts, or rolled a funeral home’s trust into a NPS trust (that subsequently purchased insurance). With regard to Missouri installment contracts, NPS apparently instructed the trustee to defer the insurance purchase until the contract was paid in full. Consequently, the consumers who are making payments on one of NPS’ Missouri contracts may have an orphaned contract.

The Missouri Insurance Guaranty Association is working with funeral homes to identify those NPS preneed contracts that are orphaned. Missouri consumers who are making installment payments on a NPS contract should contact their funeral director for assistance in determining whether their contract is orphaned or not.

With regard to these Missouri consumers, the Special Deputy Receiver and regulators need to consider that it was their recommendation that all consumers continue to pay on their NPS contracts in order to maintain coverage.

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U.S. Senator Roland Burris has been sidestepping questions about his role(s) in the IFDA master trust troubles.  While the Senator was a side issue to a March 30th article published by the Springfield Journal Register, the statement provided by his public-relations specialist may signal just how little Mr. Burris understood about his responsibilities to the Illinois public.

In an effort to shift blame to current Comptroller Dan Hynes, Delmarie Cobb wrote to the paper:

I don’t know what he has to say is relevant given that he left the comptroller’s office in 1991. When he left, the pre-need fund was in the black.

Au contraire, Ms. Cobb.

The $49+ million dollar question is why Comptroller Burris issued a seller’s license to the IFDA when it did not have a corporate fiduciary?

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Officially, its called House Committee Substitute for Senate Substitute for Senate Committee Substitute for Senate Bill 1.   Some of the ‘unofficial’ titles given this bill are not fit for publication.

It doesn’t matter who you talk to about Missouri’s current preneed reform bill, everyone has a complaint.  Even the consumer advocates.  Under normal circumstances, this general mood of discontent would ensure the defeat of a legislative proposal.  But these are not normal times, and it is appropriate that the Columbia Daily Tribune would remind the state of that fact by speaking with former Senator Jerry Howard.

In the early 1990’s, Senator Howard took on the problems of Chapter 436 and Chapter 214. While Senator Howard had success in addressing Missouri’s perpetual care law, Chapter 436 reform proved a greater hurdle.  More than a dozen years ago, representatives from the funeral and cemetery industries met with regulators to draft revisions to Chapter 436.  Although National Prearranged Service representatives attended those meetings, and provided tacit approval of the draft amendments, NPS had its own lobbying agenda.

Senator Howard took those amendment proposals to legislature, but could not obtain the necessary support of his fellow legislators.  Key legislators had been prepped for the proposals’ weaknesses.

HCS SS SCS SB1 has some flaws that need to be worked out, but time is running out for the current legislative session.  If the choice comes down to this bill or no bill, this bill should be passed with an understanding that its flaws need to be addressed by regulations and technical corrections in the next legislative session.

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The IFDA seems to be everyone’s favorite whipping boy. Even prominent industry leaders are stepping back from the Association in its time of need. The epicenter for the latest news on the IFDA’s troubles has been the Springfield Journal-Register and Bruce Rushton. Mr. Rushton has done a thorough and excellent job of reporting on the IFDA master trust. In support of that reporting, the Journal-Register published an editorial calling for action to protect Illinois consumers. In response, Springfield funeral director Chris Butler wrote to the Journal-Register to present a different perspective of the reporting and editorial. I, for one, agree with Mr. Butler that the Journal-Register is contributing to the confusion and anxieties of consumers who hold a preneed contract.

References to the IFDA master trust as a Ponzi scheme have been abused. It’s a fact that the IFDA made promises to its membership that it has not been able to keep. In a very literal sense, this may seem to fit the Ponzi scheme definition, but the IFDA master trust does not begin to equate to the Bernie Madoff fraud, or even the NPS business model. Certain factors have contributed to a liquidity problem for the master trust. The single greatest factor, the collapse of the financial markets, is completely beyond the IFDA’s control. Rather than sell off assets at a loss, fiduciaries in this situation would prefer to use incoming funds to meet liquidity needs. This is not the classic Ponzi scheme.

As Mr. Butler suggests, it is the Illinois funeral director who will bear most of the financial consequences of the master trust deficits. While there is a legitimate exposure to the consumers holding non-guaranteed contracts, the IFDA must be afforded the opportunity to do right by these consumers. Contrary to what the Journal-Register suggests, state law does not appear to ensure these consumers ‘can’t lose money on their investment’. In reality, the non-guaranteed contract purchaser has investment risk because of the decision to forego the guaranteed contract.  Granted, the consumer may not have been able to afford the guaranteed contract (and its required installment payments).  But, the non-guaranteed contract represents a fund set aside for use at a future date (without promises from the funeral home about what those funds will purchase). 

When a funeral home steps forward to honor a non-guaranteed contract regardless of the deficit, the consumer should recognize that the funeral director is covering the deficit out of a commitment to the family, and not because of a state law.   Consumers of guaranteed contracts should also appreciate that funeral homes are honoring those contracts despite legitimate controversies over their obligation to do so. 

The IFDA and its advisors made serious mistakes, but so did the regulators. Oversight fell through the cracks several years ago. Restructuring the master trust and its oversight could take years. The reform process will only take longer if misplaced criticism must be addressed at every step.

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Illinois and Missouri have more in common than they may realize. Consumers and funeral directors are blaming state regulators for their current preneed problems. Looking to avoid that hot seat, regulators have been stating their excuses/defenses. If legislators are to correct the flaws in their state’s preneed oversight, they need to put partisan politics aside and objectively assess those excuses.

In response to criticism about the IFDA master trust, the Illinois Comptroller’s office states: we don’t regulate trusts. With regard to preneed audits, the Comptroller follows the money from the consumer to the funeral home and into the IFDA trust. Once there, the Comptroller did not provide an extensive review of the trust’s activities. (Summary, it’s not my job to provide oversight once the funds make it to trust.)

The chink in the Comptroller’s IFDA armor is that the consumer funds never made it into a corporate trustee’s hands. The Comptroller’s excuse (we thought they had a corporate fiduciary) has funeral directors boiling. Rightfully so. While news reports and funeral homes have garbled the legal issues, the Comptroller’s function was to license preneed sellers, and for the IFDA, that meant the responsibility to ensure the organization had an appropriate fiduciary.

Missouri’s Division of Professional Registration and State Board of Embalmers and Funeral Directors have received the same type of criticism with regard to the NPS collapse. Those regulators have appropriately countered with explanations about how Chapter 436 tied their hands. Legislators and state agencies sponsored meetings last summer to obtain recommendations for improving Missouri’s preneed oversight. Those recommendations included the decision to continue the State Board’s jurisdiction over the preneed and to provide that entity greater licensing and oversight authorities.

Preneed regulation should begin with the licensing/registration of who may sell preneed. (I beg to differ with Ill. State Rep. Dan Brady, and those who assert preneed should only be sold by licensed funeral directors.) But that issue aside, who should provide oversight once the consumer’s funds are deposited to trust? I tend to agree with the Comptroller’s office that a state’s financial regulator is better suited for this job. However, there are ‘gaps’ to that recommendation. (State banking regulators do not have express jurisdiction over fiduciary institutions that derive their powers from a charter granted by the Office of Thrift Supervision or the Office of Comptroller of the Currency.)

While preneed licensing and payment administration oversight should be placed with a state’s agency charged with establishing minimum competency standards, oversight of the preneed trust should be with the state’s banking regulator. Federal preemption issues could be eliminated by statutory provisions that require the seller’s trustee to consent to limited jurisdiction as a condition to accepting the account. Preneed is too complex, too big, for a single state agency.

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It’s a fact that the NPS collapse threatens the viability of many Missouri funeral homes. It’s also a fact the Missouri State Board of Embalmers and Funeral Directors had jurisdiction over NPS and did not shut the company down in time to prevent the current crisis. In a response, a group of the injured funeral homes are calling for the transfer of preneed oversight to a new “commission” comprised of nine funeral directors and a consumer advocate. If this proposal constitutes the sum total of changes to be made to Chapter 436, it represents nothing more than putting lipstick on a pig.

Missouri’s State Board was never provided the tools it needed to effectively regulate the preneed transaction. Chapter 436 was intended to keep the preneed door open by establishing minimal contract and trusting requirements, without providing an effective mechanism for oversight. The State Board was never granted rulemaking authority to even address the transaction as it evolved over the years. Understanding the limitations of a state budget, the State Board’s funding for oversight was also restricted by a $2 per preneed contract fee. Restrictions were also placed on the Attorney General’s office regarding attorneys assigned to the State Board.

To suggest Missouri’s problems are simply a “governance issue” is an insult to the funeral directors who have given up their time to serve on the State Board. From time to time, there have been valid criticisms about whether the State Board members have been influenced by self-interests. But, the overriding goal of the State Board member has been the advancement of the industry’s professional standards. Current State Board members may not understand the economic nuances of all variations of the preneed transaction, but how will an expansion of preneed oversight from 5 funeral directors to 9 funeral directors ensure that objective?

The Chapter 436 review process opened last summer with the question of whether preneed oversight should be moved to an independent state authority. There are advantages and disadvantages to putting preneed oversight under an industry board. The major advantage is that the industry board should be more familiar with a complex transaction. While independent preneed regulators can be very competent (Iowa for example), more often than not, the independent preneed regulator finds the transaction as confusing as any other person. The spokeswoman for the Illinois Comptroller’s Office has acknowledged as much.

Missouri’s legislature should leave preneed oversight with the State Board and focus its attentions on providing that entity the authorities needed for effective oversight

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Consumers and funeral directors are asking their state regulators how they let the National Prearranged Services collapse to happen. With the exception of Missouri and Iowa, the NPS preneed contract was generally an insurance-funded transaction, and state insurance regulators are taking most of the heat. It is a very different story in Missouri, as witnessed by two competing reform bills: Senate Bill 1 and House Bill 853. For Missouri, NPS used a trust-funded preneed contact (that was subsequently invested with Lincoln Memorial policies). As a consequence, Missouri legislators have made higher trusting requirements and heightened fiduciary responsibilities their top priorities for both bills.

Missouri’s Chapter 436 was written before Rev. Rul. 87-127, when trusts were king. The law also reflects the historic perception of the guaranteed preneed contract (one that is shared by the Internal Revenue Service and the Securities Exchange Commission): the transaction is a sale of goods and services by the death care company.

Chapter 436 allows the preneed seller to retain the purchaser’s first payments until 20% of the sales price has been collected. A 20% sales expense retention provides smaller funeral homes the funds required to maintain a program to compete with larger operations, including the national companies. All subsequent payments must then be deposited to trust. The law was intended ensure there were sufficient trust funds for the funeral home’s “costs” at the time of performance (in contrast to the amount the consumer would have to pay for the funeral at a future date). Consequently, Chapter 436 allows the seller to also withdraw realized income to the extent the trust’s market value equaled the deposits made to trust.

What distinguishes Chapter 436 from most other permissive preneed state laws (such as Iowa) is the public policy decision to require income accrual. By requiring the trust to accrue income, these states have placed a ‘cap’ on the seller’s recovery of preneed program costs. Their message is that the seller must make do with the front-end retention of payments. These states still view the preneed transaction as a sale of goods and services (allowing the recovery of the sales expense costs), but they will not allow the preneed seller to recover other operating expenses from trust funds intended for future performances. In this respect, SB 1 and HB 853 are similar. While both would require the accrual of trust income, only the Senate bill recognizes the preneed contract as a sale of goods and services.

In an attempt to enhance consumer protection and preserve the funeral home’s ability to offer a trust-funded preneed program, SB 1 would raise Missouri’s trusting percentage from 80% to a hybrid 85%. This trusting change will have the greatest impact on small funeral homes with dedicated salesmen and the larger, proactive independent funeral home/cemetery operations.

As the retention percentage is reduced, economies of scale will make it more difficult for small operators to maintain a separate program. While the larger proactive preneed program may have the volume of sales to offset the loss of 5%, they must contend with SB 1’s ‘pro rata’ recovery of sales expense.

The retention of the sales expense from the first payments simplifies the procedures for compensating a program’s salesmen. Missouri’s SB 1 recognizes this issue in that it authorizes the first 5% of the sales price to be retained. While SB 1 allows the seller to collect an additional 10% of the contract sales price, it must do so pro ratably from each subsequent payment. This pro rata approach imposes a greater administrative burden on the seller, contributing to the costs of the preneed program.

In contrast to SB 1, HB 853 requires 100% of a purchaser’s payments to be trusted. The bill’s advocates claim the preneed funds belong to the purchaser, not the funeral home, and consumer protection will be enhanced. Essentially, the bill’s supporters are re-defining the trust-funded preneed contract as a transaction of accommodation to the preneed purchaser. Funeral homes will be required to provide program administration and tax advantages that the consumer cannot otherwise obtain from a bank.

Deprived of a source of funds to offset preneed program expenses, proactive sellers will be forced to utilize insurance funded programs. While insurance offers cost advantages to the younger consumer, many typical preneed purchasers may not qualify for insurance, or may not be able to afford the required premiums. In the end, HB 853 will reduce the preneed options available to consumers and the industry.

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John Duggan has a point, and that’s what concerns regulators in Illinois, Missouri and Texas. Who will be blamed when the consumer does not get the benefit of their preneed contract?

While the overwhelming majority of NPS’ preneed contracts will be honored by the funeral home named in the contract as the “provider”, it is not because of regulators’ threats. Most funeral directors cannot afford to abandon their preneed families. The same can be said for the IFDA members and their preneed contracts. But there will be some funeral directors who eventually decide that they cannot afford to honor those contracts. To protect the consumer, the regulator will be called on to enforce a contract that should exist between the funeral home provider and the third party preneed seller.

Many funeral homes rely upon third party sales organizations to provide preneed documents, administration, sales forces and economies of scale. While funeral directors typically relate the term “third party preneed seller” to entities such as National Prearranged Services, the term also includes those entities formed by state associations to service member funeral homes that do not want, or cannot afford, to maintain their own preneed operation. While this relationship involves the delegation of crucial responsibilities, regulators have discovered that the seller and provider have done little to document their respective rights and obligations in a formal agreement.

When the Texas Insurance Department took control of NPS and its sister insurance companies in early 2008, the initial press releases advised funeral directors that they were obligated to honor those contracts regardless of the circumstances. Texas authorities subsequently narrowed such statements to their Texas funeral directors because Missouri’s Chapter 436 does not have such a requirement.

NPS was notorious for selling preneed contracts in the absence of an agreement with provider funeral homes. Some funeral directors discovered these sales after the fact. To the extent NPS had authority to represent a provider funeral home, the agreement was often cursory in nature. Consequently, Missouri funeral homes have some justification for challenging the obligation to honor NPS contracts. In response, Missouri’s reform bill includes the following provision:

436.415. 1. Except as otherwise provided in sections 436.400 to 436.520, the provider designated in a preneed contract shall be obligated to provide final disposition, funeral or burial services and facilities, and funeral merchandise as described in the preneed contract.

2. The seller designated in a preneed contract shall be obligated to administer all payments made by, or on behalf of, a purchaser of a preneed contract and ensure the preneed contract is managed and fulfilled, and payments remitted, in compliance with sections 436.400 to 436.520 and as provided by the contract. 

 But what if the seller does not fulfill its obligations to the funeral home provider and the consumer? Is it fair to impose strict liability upon the funeral home provider?

Regulators, such as the Illinois Comptroller’s Office, seem be indicating that preneed regulation is a bigger, more complicated, task than what they are prepared for. In that vein, Missouri is warning funeral homes that they must assume the risks associated with third party sellers. Texas seems to think that consumers would be best served by the prohibition of trust-funded third party preneed contracts (154.1013). I disagree.

Insurance funded preneed is not an option for many elderly consumers. If faced with trust funding or POD/joint accounts, smaller funeral homes will be squeezed out of the trust arrangement by the expense of establishing and maintaining their own trust. Funeral homes will also have to comply with the seller licensing requirements.

Despite the allegations made against the IFDA, the state association trust may represent the only competitive preneed product available to the smaller funeral operator.

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The Missouri Legislature has reform of Chapter 436, the preneed funeral law, on the fast track. With the speed that Senate Bill 1 has been amended and perfected, it may be more appropriate to label this reform as being in the express lane. However, Missouri legislators must not lose track of the cemetery industry’s efforts to effect its own reforms for Chapter 214.

As with most states, Missouri regulates cemeteries under a separate law and a separate regulator. For the most part, Missouri’s cemeteries have been spared from the NPS abuses. Regardless, the state’s cemetery industry has been pursuing needed changes to Chapter 214. Appropriately, Senate Substitute for the SCS SB1, attempts to carve out cemetery exemptions from preneed funeral regulation, but misses the mark.

Chapter 333 vests regulation of funeral directors and funeral establishments in the State Board of Embalmers and Funeral Directors. SB1 will expand the State Board’s authorities to regulate the preneed transaction, and the revisions to Chapter 333 include new definitions of “funeral merchandise” and “preneed contract”. Those definitions overlap with the property, merchandise and services sold by cemeteries. To exclude cemeteries from the State Board’s jurisdiction, SB1 includes a new Section 333.310:

333.310. The provisions of sections 333.300 to 333.340 shall not apply to a cemetery operator who sells contracts or arrangements for services for which payments received by, or on behalf of, the purchaser are required to be placed in an endowed care fund or for which a deposit into a segregated account is required under chapter 214, RSMo, provided that a cemetery operator shall comply with sections 333.300 to 333.340 if the contract or arrangement sold by the operator includes services that may only be provided by a licensed funeral director or embalmer.

With Chapter 333 now defining funeral merchandise to include grave spaces, markers and vaults, cemeteries that sell these items on a preneed basis will be subject to the State Board’s licensing jurisdiction. Section 333.310 exempts cemeteries from the State Board’s jurisdiction to the extent that the cemetery sells only preneed burial services such as opening and closings (and then one has to question the exemption’s reference to endowed care fund or segregated account). If the cemetery sells property or merchandise, the State Board would have jurisdiction for requiring preneed licensing.

In contrast, the cemetery exemption from Chapter 436 does not reference services (and consequently, has a broader affect):

436.410. The provisions of sections 436.400 to 436.520 shall not apply to any contract or other arrangement sold by a cemetery operator for which payments received by or on behalf of the purchaser are required to be placed in an endowed care fund or for which a deposit into a segregated account is required under chapter 214, RSMo, provided that a cemetery operator shall comply with sections 436.400 to 436.520 if the contract or arrangement sold by the operator includes services that may only be provided by a licensed funeral director or embalmer.

However, the Chapter 436 exemption is also problematic for cemeteries. This provision would exempt contracts sold by cemeteries where the purchaser payments are deposited to an endowed care fund or to a segregated account required under Chapter 214. This provision is rather confusing because endowed care trusts cannot be used for preneed payments, but rather for the care and maintenance of the cemetery. The reference to “segregated accounts” contemplates Section 214.387, a provision that authorizes cemetery operators a procedure for deferring the delivery of markers pursuant to a purchaser’s instructions. The segregated account does not provide adequate consumer protections, and should not be the basis for an exemption from Chapter 436.

If would be preferable to address Chapter 436 and Chapter 214 at the same time so that the exemptions can be dovetailed, but if Chapter 436 continues on its current pace, the cemetery exemption must contemplate future trusting/escrow arrangements under Chapter 214, or provide the Director of the Division of Professional Registration the authority to exempt cemeteries based on their individual preneed programs.

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Has the economy caused consumers to put preneed on a back burner? Perhaps, but funeral directors can anticipate an increase in spend down inquiries. It is hard to turn prospective business away, but funeral directors need to consider how these transactions do not lend themselves to insurance funding or the conventional guaranteed preneed contract.

In many situations, these families cannot afford a full traditional funeral. Over time, they may be able to contribute funds to pay for most of a funeral (depending upon the expense of the casket), but they cannot commit to regular monthly payments. Often, payments may be several months apart. A funeral home cannot freeze its prices if the family cannot commit to paying the required price within a specified time.

But, what are the funeral director’s responsibilities with regard to the non-guaranteed payments? Does the funeral director become a guarantor of the payments received on the non-guaranteed contract? This is one of the ‘lesser’ issues in the IFDA master trust controversy.

Last October, the IFDA included the following explanation on their website:

Non-guaranteed contracts are subject to the ups and downs of the market – like many other investments. Their principal is protected by the funeral director who sold them the “non-guaranteed” preneed policy.

Today, the IFDA website is a bit less forthright about the non-guaranteed contract:

The very nature of a "non-guaranteed" preneed contract is earnings are not guaranteed, but the amount of principal paid by the consumer is protected. The value of non-guaranteed contracts is determined at the time of need and any paid principal is a deposit toward the final cost. If there are any earnings in the Trust investments, those earnings are credited toward the final purchase price. But if there are no earnings, the amount of principal paid is still protected by law and applied on behalf of the consumer to the final purchase price.

Unless the non-guaranteed payments are invested separately in government-backed securities, the consumer will ride with the funeral home in the ups and downs of the market. To suggest the consumer will at least get his deposits means that the deficit has to be funded out of the trusts assets, at the expense of the guaranteed contracts.

Last summer, the Missouri Funeral Directors and Embalmers Association made a POD/bank account proposal during the state’s reform hearings. While the proposal has merit, state attorneys were quick to point out that POD bank accounts cannot be excluded from a consumer’s assets for qualification testing. In other words, you need an irrevocable trust for spend down purposes.

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The Missouri Senate Committee assigned the task of preneed funeral reform posted a substitute bill to the Legislature’s website on February 6th: SCS SB1. For those who participated in the Chapter 436 Working Group meetings last summer, this bill may seem vaguely familiar. During those meetings, the Division of Professional Registration circulated a 41-page draft proposal for discussion with industry representatives. However, discussions regarding the proposal bogged down when industry members could not agree over several issues. Eventually, the Working Group issued a “Recommendations” statement.

Turning back to the Division staff, the Senate committee has dusted off that earlier draft proposal and added provisions based on the Chapter 436 Working Group Recommendations. This approach is sure to revive the disagreements that derailed last summer’s meetings.

With the NPS failure as a backdrop, the Missouri legislature will have little patience for the internal bickering that has marred prior reform efforts. While SCS SB1 has some legitimate flaws, the status quo is no longer an option.

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Greed

Funeral directors who rejected NPS’ promises may feel justified in criticizing those who are asking for help. Generally, their criticism is that NPS exploited funeral directors’ greed. With regard to some trust rollovers, that may be true. But, what NPS best exploited was funeral directors’ desire to devote their time to the service of families rather than preneed.

NPS grasped that many funeral directors felt the need for a proactive preneed presence, but did not have the time, resources or inclination to establish their own program. NPS offered to take care of all the details, with at-need prices to boot. Hindsight is 20/20, but funeral directors should have asked questions and requested documents. But what questions?

Perhaps as an acknowledgement that competition is forcing members to use proactive preneed programs, the NFDA has issued guidelines for evaluating preneed insurers and preneed trusts. During the months that followed the Clayton Smart and Robert Nelms arrests, the NFDA drew criticism for its failure to provide leadership in addressing the growing preneed scandal. Some of the more stinging criticism came from the association’s smaller cousins.

These critics rarely address the elephant in the room: our fragmented, state-based approach to preneed regulation. The New York Funeral Directors Association has an excellent consumer protection statute to work with, but you can’t judge other trade associations without looking at their laws. And, the NFDA has to consider all fifty states when it issues policy guidelines.

If the NFDA’s Guidelines For Evaluating Preneed Trusts seems general and vague, it is because those 50 states’ laws differ substantially, many of which are poorly written. Preneed laws are often compromised efforts that include purposeful ambiguities. Those ambiguities can come back to haunt us years later when a new appointee fills the regulator’s chair.

The NFDA’s task is made even more difficult when suggesting questions that will be asked of member’s state association master trust.  But the times demand action.

Taking the NFDA Preneed Trust Evaluation a step further, funeral directors should also request certain documents regarding prospective program sponsors.

From state regulators, determine whether audits are performed of the program. If so, request the most recent audit report. Also inquire whether there have been any disciplinary proceedings during the past three years. Open investigations may be subject to confidentiality requirements, but closed proceedings may be subject to open records requests.

From preneed program sponsors, request the three cornerstone documents: the master trust agreement, the participation/provider agreement and the preneed contract. Determine from the program sponsor whether applicable state law authorizes collective trust investments, and if so, request the sponsor’s guidelines for unit pricing and income/expense allocations. Also request a breakdown of the trustee/administration expenses by: custodial services, fund management, sub-account administration, audit and tax return preparation and reporting. If the master trust utilizes insurance products, request a written explanation of the product’s taxation.

As IFDA members are learning, preneed due diligence is an ongoing obligation. Funeral directors must find the time to periodically review their preneed program by asking the right questions, and getting the answers in writing.

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It didn't take long for an Illinois funeral director to confirm that IFDA members have disagreements with their association leadership. 

Several Illinois funeral homes filed a lawsuit in Cook County Circuit Court on January 28th.  The petition, a derivative complaint, seeks remedies and damages on behalf of all Illinois funeral homes that participated in the IFDA master trust.  Various IFDA officers, board members and agents are named the defendants.  The defendants include Merrill Lynch, in its capacities as an advisor to the IFDA. 

The Derivative Complaint asserts facts that indicate the IFDA not only concealed critical information, but mislead funeral directors and consumers.  However, the Complaint does not answer the question from my prior post:  Who is the seller of the IFDA preneed contracts?

Page 20 of the Complaint approaches the issue with a discussion of "Participating Member Firm Agreements", but ultimately sidesteps the question and its legal ramifications. 

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Last October, the Illinois Funeral Directors Association posted some “Frequently Asked Questions” on their website. The FAQ page was intended to address questions and concerns raised by funeral directors and consumers about changes being made to the IFDA Master Trust. Page 6 of that FAQ was addressed to the Illinois families that had purchased an IFDA preneed contract, advising that “consumers should feel perfectly confident” in those contracts, and that “guaranteed preneed contracts are guaranteed to provide services in full”. With regard to non-guaranteed contracts, the IFDA represented that the contract’s “principal is protected by the funeral director who sold them”.

If the Class Action Complaint filed last November is an accurate barometer of consumer confidence, the IFDA leadership missed the mark with the public that it’s members serve. Documents also suggest that IFDA leadership has been less than candid with the funeral directors they have pledged to serve.

The current IFDA website offers an explanation that suggests cooperation with regulators, and the presence of financial circumstances that caught everyone off-guard. For consumers, the IFDA offers assurances to the preneed purchaser that the transition will have “very little, if any, impact on them because both ‘non-guaranteed’ and ‘guaranteed’ preneed contracts contain protections for consumers”. The IFDA represents the following:

In the case of “guaranteed” preneed contracts, Illinois law clearly states those contracts are guaranteed and funeral directors are to provide those services in full. 

The message to funeral directors is that they must service these contracts regardless of what is in trust to pay them.

Time to step back and look at theIllinois law and the IFDA preneed contract.

The requirements of guaranteed preneed contracts are set out in 225 ILCS 45/1a-1. Pretty typical of the provisions imposed by other states, but not quite consistent with the IFDA representation. In general, there are two promises made through the guaranteed preneed contract: the purchaser promises to timely pay the sales price according to the contract’s terms, and the contract seller promises not to charge the purchaser any additional amounts for the goods and services described in the contract at the time of the beneficiary’s death.

When the preneed seller and the preneed provider are the same party, the funeral home is on the hook to service the contract regardless of how well the trust performs. But, the funeral home’s legal obligation to perform a preneed contract becomes more complicated when a third party seller is involved. Illinois law authorizes third party preneed sellers so long as disclosures are made in the preneed contract. The $264 million question: the who is the seller of the IFDA preneed contract?

The IFDA has probably used different versions of a guaranteed preneed contract form over the years, but a 2006 form provides clear definitions of “Trustee”, “Provider”, “Purchaser”, “Beneficiary”, and “Depository”, but no definition of “Seller”. There is a single reference to Seller, where the Purchaser is required to acknowledge an explanation of the contract. The context of that provision would suggest the funeral director is the seller. However, Paragraph 15 of the contract muddies the waters.

Per Illinois law, preneed sellers are allowed to retain a portion of the purchaser’s payments. Paragraph 15 is intended to authorize the retention of such amounts, but references the “Trustee, Provider and Depository”. Which one of these entities is the seller? (We can probably rule out U.S. Bank Corp.)

Without the benefit of the agreements and documents that may exist between the IFDA and its member funeral homes, the answer may be reflected by conduct and the application of the Golden Rule. Not that Golden Rule, but rather: he who has the gold, rules.

This would not be the first time an association’s leaders placed control of its master trust above the interests of consumers and its members. The Minnesota Department of Health had such an experience. That association even challenged regulatory orders for the dissemination of information to funeral home members. In the end, the association was forced to enter a Stipulation and Consent Order, and to provide information to its members.  Individual funeral homes also signed consent orders that allowed them protect the consumers by assuming control of the trust funds sold in their name. 

Resolving the problems of the IFDA Master Trust will be far more difficult than following the Minnesota example. If the $160 million of life insurance held by the master trust is key man insurance, the IFDA’s valuations need to factor in the proper tax consequence. Hopefully, the IFDA board members purchased some errors and omissions insurance coverage at the same time they purchased those key man policies.

If the IFDA and its membership are in a dispute over the management of the master trust, the Illinois Comptroller holds the key to breaking the logjam.

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I learned the preneed business from an organization that used the term “preneed counselor”. Consumer advocates, and many funeral directors, rail at that characterization, and insist a salesman is a salesman, no matter what you call them.

For purposes of debate, I would agree that all preneed counselors are salesmen. However, not all preneed salesmen are counselors. While both have to make a living, the counselor places an emphasis on education. But, the distinction between the counselor and the salesman is made difficult by the fact both tend to be compensated on the commission basis. This rubs the public and many funeral directors in the wrong direction; a fact not lost on proactive preneed sellers.

The Catholic Cemetery ran “Point – Counter Point” articles in its December and January editions on the advantages of commissioned-based programs and salary-based programs. Rich Peterson, of the Archdioceses of Seattle, led off with a description of how his “Pre-Need Sales Counselors” perform outreach to a Catholic population that is scattered across a large geographic area. Demographics and geography force the Pre-Need Sales Counselor to go to the families.

Richard Touchette, of the Dioceses of Albany, uses salary-based “Family Service Representatives” to perform outreach to an ‘entrenched’ Catholic population. In contrast to its Seattle counterpart, most of the outreach performed by the Family Service Representatives is done at the Dioceses’ cemeteries.

As Mr. Peterson explains in this article, all preneed programs have costs such as training, staffing and advertising. Mr. Peterson could have gone farther and addressed the costs associated with contract administration, regulator compliance and document development. However, the program that must seek out its targeted audience will always have greater costs per sale. These organizations must be more “proactive” in making their connections to families. The salesmen must spend substantial time away from the cemetery’s offices. Cemeteries and funeral homes with ‘heritage’ may adopt a more passive approach to preneed marketing, and can better handle preneed sales with a salaried staff that remains on the grounds.

Another factor in the commission vs. salary issue is applicable state law on trusting requirements. When a state sets its trusting percentage at 100%, or even 90%, the preneed program must be funded to some degree from the cemetery’s general revenues. Mr. Touchette’s cemeteries are subject to a much higher trusting requirement than Mr. Peterson’s. Consequently, the Dioceses of Albany cemeteries cannot recapture all of these preneed costs at the inception of the sale. A high trusting requirement is even more detrimental to a cemetery than a funeral home.

Funeral homes are not called upon to perform a preneed contract until there has been a death. When state trusting requirements prove too high to fund a preneed program, a funeral home can turn to insurance funding and use the commissions paid by insurance companies to pay counselors/salesmen and offset program costs. In contrast, cemeteries often deliver preneed property and merchandise prior to the purchaser’s death, which precludes insurance funding. Consequently, cemeteries must use trust funding or constructive delivery.

The proactive preneed program will always be distinguished by marketing and outreach that consummates a transaction someplace other than at the operator’s offices. While all cemeteries and funeral homes strive for the heritage that brings families to their door, most face challenges and competition that require them to reach out to their families. Few individuals have the personality and commitment to walk into a family’s home to discuss mortality. For better or worse, the industry has compensated these individuals on a commission basis.

With NPS, the worst was encouraged with commission rates that allowed salesmen to make six figured salaries at the expense of elderly consumers. As one of the states hardest hit by the NPS failure, Missouri’s legislators will be pressured to impose tougher trusting requirements on all preneed programs. Rather than punish all preneed programs by instituting 100% trusting, Missouri should consider a cap on the commission that may be paid to the preneed salesman.

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A trade newsletter recently reported on funeral homes forming buying groups to negotiate better terms with casket vendors. Through cooperative alliances, the funeral homes can achieve the numbers required to negotiate better discounts from vendors. Those same economies of scale also benefit preneed programs that utilize trust funding. The larger trust not only provides the operator leverage in negotiating terms with a fiduciary, the trust provides the asset manager the critical mass required for a sophisticated asset allocation model for proper diversification.

However, state laws are often a hurdle to independent funeral homes or cemeteries seeking to form a master trust that would commingle funds from multiple sellers. Laws such as Missouri’s Section 436.031 authorize collective investing by preneed trustees, so long as the funds deposited belong to a single preneed seller. This restriction reflects a legislative concern for the trust’s accounting of deposits, distributions, income and expenses.

Rather than close the door completely on collective investment trusts, the Michigan cemetery law signed into law last week left the door open to a new breed of master trusts.

Section 16 of SB 674 establishes a transition period for Michigan cemeteries to transfer their endowed care trusts to corporate fiduciaries. Subparagraph (2) of that section addresses the traditional master trust established by a single cemetery that has multiple trusts or a master trust among multiple cemeteries with common ownership. The subparagraph also references preneed trusts. The opening for pooling among unrelated trusts comes in subparagraph (3) where Michigan’s cemetery commissioner is given the authority to approve ‘other comparable methods of bundling or pooling of trust or escrow funds for investment purposes’.

The fiduciary services provided by national banks are subject to Federal regulations set out in 12 CFR Part 9 (“Reg 9”), and more specifically, collective investment funds are subject to 12CFR 9.18. State chartered fiduciaries and Office of Thrift Supervision chartered fiduciaries are subject to similar requirements. The fiduciary’s authority to pool preneed trust accounts is derived from 12 CFR 9.18(c)(4). The regulation sends the fiduciary back to state law for its authority, and prohibitions. In the absence of express authority (and express prohibitions), the fiduciary is in ‘no man’s land’ with whether it is required to follow the requirements of Reg 9, which include a written plan, audits and asset valuations.

The Michigan law seems to appreciate that Reg 9 requirements go beyond what should be required of a preneed master trust, and appropriately, make the non-traditional master trust subject to a case-by-case approval. The test will be whether the proposed pooling arrangement has sufficient accounting procedures to protect participating operators and their consumers. Missouri is particularly sensitive to this issue in light of the NPS failure, and its procedures for trust rollovers.

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In reporting on Forethought’s cut in growth payments last month, the Funeral Service Insider made a curious statement about the taxability. Referencing one of Forethought’s products, the article stated that a funeral home would have received the product’s growth tax free, and now would have to recognize the bonus as income. The article suggests that Forethought’s executive replied by advising that the taxability of the bonus would depend how the funeral home handles it.

Excuse me, but how are insurance proceeds or bonuses not taxable to the funeral home?

If a preneed insurance carrier is suggesting that policy proceeds are not taxable to the funeral home that accepts policy proceeds as consideration for performing a preneed contract, how does that company explain the transfer-for-value rule?
 

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It has to be bad when your main source tells you its time for the Methadone clinic. With the worst financial crisis in our lifetime, and spiraling costs, what funeral director isn’t already battling a case of the sweats and shakes when reviewing his/her preneed program?   And now you’re being told to go cold turkey on the only preneed transaction that you offer.   

With Forethought having joined the bandwagon against the guaranteed preneed contract, funeral directors are being forced to reexamine the transaction.  It is an examination that is long over due. However, dropping the guaranteed contract will not be as simple as Forethought suggests. 

 

For fifty years, the US funeral industry has defined preneed as a cost saving transaction that will provide peace of mind to the "consumer".  As many funeral directors recall, Forethought/Batesville taught them how to structure this transaction around the casket sale. And, now they tell the funeral director it’s a mistake. No wonder some funeral directors are a bit miffed with their insurer. Funeral directors that embrace Forethought’s prescribed medicine could suffer sharp withdrawal pains that have long-lasting side effects.   

 

Preneed insurers are crucial to most preneed programs, but funeral directors need to appreciate that their insurers are responding to changing market forces. Insurers are looking for alternative markets, and consequently, we are hearing more about ‘final expense policies’ and ‘funeral expense trusts’. These products can be marketed independently of the funeral home, relegating the funeral director to an end provider.   For the funeral home that maintains an insurance agency, the final expense product offers a larger commission. But, the final expense product also targets a more affluent consumer. How many of your consumers are candidates for a $20,000 policy that provides a 2% return, and requires a $200+ monthly premium?

 

Rather than go cold turkey on the guaranteed contract, the industry will begin to explore hybrid contracts that provide partial cost protections. For the older, and less affluent, consumers, the industry needs to look at cooperative trust arrangements similar to those offered in England, Canada, New Zealand and Australia.   With regard to these alternative trusts, we face a 'minor' hurdle: our preneed exemption from certain securities regulations is based on the guaranteed contract being a sale of goods and services. 

 

To facilitate the administration of preneed contracts and trusts, the Securities and Exchange Commission has issued a series of “No Action Letters” regarding the preneed contract or the preneed master trust. See, e.g., Fleet National Bank (Sept. 5, 1990); Funeral Services of Iowa, Inc. (September 28, 1987); Michigan Funeral Directors Association (August 27, 1987); Associated Funeral Directors Service, Inc. (September 5, 1986); Drexel Trust Company (September 12, 1983).

 

For purposes of collective investment, the trust-funded, non-guaranteed preneed contract will need to utilize an alternative exemption from the SEC regulations. 

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For twenty-two years many Missouri funeral directors have deposited 80% of the preneed funeral contract purchase price into trust, and withdrawn all income in excess of that deposit. For a $5,000 contract sold in 1998, the funeral director has been required to maintain $4,000 in trust. When that contract is performed in 2008, the funeral director is authorized under Chapter 436 to withdraw an amount equal to that deposited to trust: $4,000. Today, and for the foreseeable future, that distribution will exceed that contract’s ‘value’ under the mark-to-market approach. Depending upon the facts of a particular trust, the difference between these two approaches could exceed the trust’s annual realized income. This puts the trust further into the hole and threatens the funeral director’s long-term viability.

Assume the funeral director has a $1,000,000 trust with a contract population that averages 10 years in duration. On the average, 10% of the trust’s contracts are serviced each year, or $100,000. Depending upon trust’s asset allocation, the current financial crisis could have trimmed a third of that trust’s value. If a 25% value decline is assumed, the funeral director’s trust is worth $750,000. If the trust’s value remains ‘flat’ over the next year and the funeral director services 10% of the trust’s contracts, he will withdraw $25,000 ‘excess’ value over the next year, or 2.5% of the trust’s value. For trusts invested exclusively in fixed income, the difference may exceed the trust’s actual return.

Switching to the mark-to-market approach will be painful for funeral directors. For that ten-year old, $5,000 preneed contract, the funeral director would receive $3,000. Today, that service might sell for $6,500. The cost to provide the service will vary from funeral home to funeral home, but many will find it difficult to do so for a profit when only paid $3,000. Of course, there has been income distributed from the trust over the past ten years, but not necessarily to the funeral director performing the contract.

Consequently, Missouri legislators need to consider two important Chapter 436 revisions: the mark-to-market approach and trust income accrual. If the Missouri funeral director had accrued the income and earned a net 3.5% over the past 10 years, the mark-to-market approach would have paid the funeral director $5,642 instead of $3,000.

The mark-to-market approach has proven a bitter pill for Illinois funeral directors, and legislators should expect a similar reaction from some Missouri funeral directors.  The legislature can not retroactively apply the mark-to-market approach, but funeral directors need to consider whether the approach is in the best interests of existing business.
 

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When its Halloween, the media is naturally attracted to a story that involves horror and a cemetery.  The Belleville News-Democrat found a new type of horror for its seasonal article involving a cemetery: Missing Trust Funds!

For added suspense, the newspaper reports there are two cemeteries, and both were (or are?) owned and operated by Forever Illinois, a sister corporation of National Prearranged Services.  Determining who owns and operates the cemeteries seems to be an issue of confusion for the Illinois regulators.  The cemeteries have turned into a hot potato.

Concerns over the Forever Missouri cemeteries had to have influenced Missouri regulators' efforts to seek new enforcement authorities in Chapter 214.  Unlike their Illinois counterparts, Missouri regulators lack clear authority to involve either the attorney general's office or local prosecutors. 

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In terms of the toxic NPS fallout, Texas ranks a close second to Missouri.  In response, the Texas Department of Banking has released a legislative proposal aimed at closing what it perceives are the loopholes in Chapter 154 of the Texas Finance Code. 

To facilitate discussion of the issues with death care operators, insurance companies and fiduciaries, the Department of Banking released an Explanation of Intent of Proposed Changes.   A few of the DOB issues include:

• Putting cemeteries on notice that they could be defined as a "funeral provider".
• The seller/permit holder must exercise reasonable controls over contract administration.
• The elimination of third-party preneed sellers.
• A minimum net worth of $100,000 for permit holders.
• A standard information brochure that covers both forms of funding.
• Income allocation requirements for non-guaranteed items.
• Distribution documentation.
• A new guaranty fund.

 

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The IFDA master trust turned a new page today, and for participating funeral homes, the first step in a long recovery process.  With the appointment of Merrill Lynch Bank & Trust as a temporary trustee, the association begins the process of looking for a permanent trustee.  The appointment also coincides with the trust's accounts being put on a mark-to-market basis. 

The mark-to-market approach taken by the IFDA master trust will mean that the trust's value will be allocated among the preneed contracts each month. Until the benefits of key man insurance purchased by the master trust are realized, funeral directors will be servicing contracts for far less than they were promised.  It was not clear from the Q&A circulated to funeral directors whether insurance proceeds will be allocated to preneed contracts serviced while the actuary study is being performed. 

Funeral directors who left the IFDA master trust for NPS must feel whipsawed by these circumstances.  

Missouri funeral directors questioning reporting requirements being considered by the legislature should note that the IFDA reports its preneed contract values to consumers annually. 

 

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Two class action lawsuits were filed last year over the mismanagement of Grandview Memorial Gardens (Madison, Indiana), and a settlement has been reached in the suit involving the cemetery’s preneed trust funds. Over the course of about 14 years, the cemetery went through three changes of ownership, four trustee changes and sold several million dollars of preneed contracts. When Indiana regulators examined the Grandview preneed trust in 2006, they found $144,000 of assets. Then the regulators began to tally the cemetery’s preneed liabilities, but found those obligations exceeded the trust’s balance before they got to the purchasers whose names began with “B”.

With regard to the fiduciaries that administered the Grandview trust, the plaintiffs’ attorneys included one basic discovery request that may have proved damaging to the banks: show us your policies and procedures for administering a preneed account. The Office of the Comptroller of the Currency has issued written guidance to national banks advising of the need for internal controls, and policies and procedures for the preneed account. Taking a page from the OCC memorandum, the Grandview attorneys focused their discovery on the banks' oversight of Grandview's preneed trust.

Specifically, the discovery sought to confirm that each fiduciary had accounting procedures to determine whether: (1) distributions exceeded an account’s deposits and income, and (2) deposits could be identified by a particular preneed purchaser.

While the settlement does not represent an admission by the defendants, the fiduciaries agreed to pay $216,000 to the plaintiffs. 

 

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Funeral homes and cemeteries are businesses that serve families when they are most vulnerable. To guard against exploitation, the death care industry establishes standards of professionalism, and state governments pass laws and regulations. Consumer advocacy plays an important role in educating consumers about these standards, and providing families tools in evaluating death care operators. To best serve their members, consumer advocates must be informed and objective in responding to potential abuses. If not, these organizations can discredit their purpose and damage their relationships with the death care industry. 

A Fort Myers newspaper ran a recent story about the frustrations of an elderly couple that wanted to trade in their burial crypts for cremation services. The story indicates the couple had purchased two burial crypts more than a decade ago, and became angry when the cemetery would not provide a credit equal to their original purchase price. The story relies upon Bill Swain, President of the Florida Funeral and Cemetery Consumer Advocacy, to flesh out the facts and to provide a perspective. In doing so, Mr. Swain seems to have spun the facts in an attempt to kill two birds with one stone: labeling the cemetery as greedy and disparaging preneed.

In response to the cemetery refusing to re-purchase the burial crypts from the couple, the paper attributes the following to Mr. Swain:

This is one of the drawbacks of prepaying for any funeral needs, ….

Why not just give them the money back when (the cemetery) can sell it for three times as much?

The laws in Florida are on the side of the funeral business, not on the consumers.

It is no secret that consumer advocates oppose preneed, and a casual read of the story would suggest that this is another example of preneed abuse. The couple also has the perception that the cemetery has been earning interest on the funds paid for the burial crypts. However, the story is misleading, and one can question whether Mr. Swain is responsible.

It is not clear from the facts whether the couple even purchased their burial spaces through a preneed contract. If the couple went to the cemetery, paid the purchase price and then received a deed to the spaces, that does not constitute a preneed transaction. If the spaces were purchased through a preneed transaction, the news report indicates the couple own the spaces, and therefore, one can conclude they received the property they contracted to purchase.  Consequently, Mr. Swain’s statements are misleading, particularly when you attempt to reconcile the 3rd statement from above with the FFCCA website:

Friends and Neighbors: The Governor signed SB 528, "The Sen. Howard Futch Memorial Act," into law!! We win!!! Whee!! Thank you, ALL of you, both industry and consumerr reps, for the support you gave our good cause. NOW...(you knew this was coming, didn't you?), we have to stay on top of the process by which the new regulatory structure will be put in place. Please stay alert. The effective date to implement "our" legislation is October 2005. There are lots and lots of critical dates between now and then, and we (FFCCA) will keep you informed. Let's all take a few deep breaths and yell: "Yeeeee-haw!! Bill Swain

Putting the preneed issue aside, another question is whether Mr. Swain is suggesting that cemeteries should refund a burial space purchase price whenever the owner changes his mind. If so, then it’s fair for the Florida death care industry to question whether Mr. Swain has made the necessary effort to become informed, and whether he can be objective in responding to consumers and reporters.

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Part of the bad rap against preneed stems from the salesman who is prepared to say anything to close the sale. While, reputable companies build safeguards into their programs to check this behavior, there will be individuals who are prepared to bend the rules. Who should be held accountable when the agent intentionally violates the company’s safeguards? That question was raised, but not answered, during Missouri’s Chapter 436 Review Committee hearings. For some Missouri funeral directors, the issue is being presented in a context that they do not yet appreciate.

NPS’ sudden demise left an aggressive sales force scrambling to find new jobs. Some of the NPS salesmen joined established insurance companies, and others established their own insurance agencies. While some of the former NPS employees were also victims of the company’s misrepresentations, funeral directors need to appreciate that NPS did not think enough of compliance to teach it to its employees. Consequently, funeral directors should be asking whether these salesmen are receiving proper oversight from their new insurance companies.

Some of the former NPS salesmen signed on with a national insurance company that offers a ‘funeral expense trust’. That trust represents a product the insurance company can offer to consumers who cannot purchase the company’s insurance product directly through a licensed agent.

Some preneed sales entities have taken the concept a step further, and are marketing the trust in states where the insurance can be purchased as a preneed product that is independent of the funeral home. Innovative NPS salesmen now seem to have taken the concept even further, marketing the concept as a vehicle available to funeral directors who are not licensed insurance agents. It is not clear whether the sponsoring insurance company has approved of either of these modifications to the funeral expense trust.

One of the persistent rumors regarding NPS’ business practices in 100% trust states, was that the company circumvented insurance licensing requirements by effecting insurance purchases through a trust. The rumors also suggested that NPS found ways to split commissions with the funeral directors even though they are not licensed insurance agents. Funeral directors are beginning to relay similar stories, but with new insurance company names.

So, if these salesmen have formed preneed marketing programs that violate applicable preneed laws, is the insurance company responsible to the funeral director if disciplinary actions are brought against the funeral establishment license? Most state regulators will likely find the funeral director has a duty to understand the licensing requirements and commission restrictions imposed by applicable state insurance laws. Funeral directors are putting their livelihood at stake when they do not question a salesman’s explanation about how ‘we have a way around that problem’.
 

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While the Wall Street bail out plan has many flaws, one of its proposals has wide-based support: the concept of increasing the limit on insured deposits to $250,000.  According to the New York Times, the driving force behind this proposal wasn't the mega-banks, but rather our local banks.  

The Independent Community Bankers of America represents approximately 8,000 local banks, and employed a grassroots approach to prevail over the proposals of the larger financial institutions.  The organization's president stated that "we might be small, but we're pretty nimble."   Words funeral directors may want to keep in mind when they attempt to respond to legislative efforts this winter.  

If the Wall Street bail out passes with the $250,000 FDIC limit, small funeral operators will have more flexibility in using deposit accounts as preneed funding. 

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During the long and tedious Chapter 436 hearings, some Missouri funeral directors joined consumer advocates in using the NPS failure as reason for recommending that legislators impose 100% trusting on the preneed transaction.  Those funeral directors generally advocated the use of insurance or joint accounts as safer methods of preneed funding.  During regulatory meetings, comments were also made about how the insurance policies or joint accounts were 'guaranteed'.   The realities are that each of these forms of funding has its advantages and disadvantages, and that there are no absolute guarantees.

The AIG failure underscores that even the largest of insurers may be vulnerable to the current financial crisis.   While most life insurers are safe, the only guarantees offered by insurance are the rates of return promised by the policy terms.  As witnessed by the Texas insolvency proceedings for Lincoln Memorial life, the insurer's promises are only as good as the assets held in its reserve accounts.  After that, the policyholder must look to guaranty funds for assistance.  Consequently, funeral directors should periodically review the financial statements of the insurance companies they use for preneed funding.

With regard to keeping those preneed funds at the local bank, the funeral director is assuming risk (and liability?) when he exceeds the FDIC insurance coverage.   By holding the consumer's payments in a joint capacity, the funeral director is also exposing the funds to the claims of the funeral home's creditors.   Losing a lawsuit for damages that exceed the firm's casualty insurance put the consumers at risk. 

In contrast, the funds placed in a preneed trust are not the assets of the bank or the funeral home.   By virtue of the terms of the preneed contract, the funeral director usually has the risk of investment performance (and under the current circumstances, that's more risk than what some funeral directors want).  But in contrast to insurance and joint account contracts, the trust provides the death care operator some say in how investment risk should be handled.

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Dear Donna,

Once the liquidation plan is finalized, and the procedures for paying claims are implemented, could we please revisit the issue of the Missouri installment contracts?

Yes, you have been patient and polite regarding my inquiries.  But, until this past Monday, I did not know how significant an issue these contracts were.  If I am interpreting Note 3 from the Statement of Assets - Explanatory Notes correctly, Missouri consumers owe $23 million on outstanding NPS preneed contracts.  As I explained in my May letter, these consumers are paying too much. 

Thanks, again.

Bill

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Why did you agree to that?

That's the question I have been getting to the Chapter 436 Working Group recommendations regarding i) the deposit of all purchaser payments to trust, and ii) some form of periodic statement to the consumer.   One answer would be that we see too many news reports like this one.  

The primary objective for these two recommendations is the establishment of an audit trail.  Require all payments to go through the fiduciary's hands, and require the fiduciary to give the consumer some form of notice.  If the regulator does not have the resources to monitor the transaction, give the consumer the opportunity to do so.  The recommendation does not deny the seller the right to recover sales expenses.

Yes, the procedure is burdensome, will add cost to the transaction, and will require change.   What are the alternatives?

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Concurrent with the hearing held on her Liquidation Plan, the Special Deputy Receiver posted a financial report to the Lincoln Memorial Life/NPS website. As with most financial statements, explanatory notes at the end of the report provide some insights to the failed NPS empire. While prior documents have disclosed that the companies have a deficient of nearly one billion dollars, the SDR report breaks that number down in terms of trust funded contracts and insurance funded contracts. 

Insurance funded preneed contracts account for almost $600 million of the unfunded deficit, twice the number of that for trust-funded contracts ($289 million).   The explanatory notes identify six trusts maintained by NPS. The notes identify Trust VI as that of Iowa, and the size of Trust IV would suggest that it was for Missouri. One of the other trusts may be a special account, and if one were to assume the other three are other ‘state trusts’, that would leave the other 15 NPS states as exclusive insurance funded states. There is no doubt that NPS exploited Missouri’s laws regarding trust funded contracts, but a greater harm was done to consumers through NPS' exploitation of state laws governing insurance funded contracts.

 

Of the NPS trusts, the Missouri deficit is the largest by far ($248 million). This number has been isolated to Missouri regulators as justification for raising the state’s trusting requirement to 100%. That argument ignores the fact that Iowa also has an 80% trusting requirement, yet only has a deficit of $23.5 million (a tenth of Missouri’s). The difference can be attributed to the difference in oversight and regulatory requirements. The argument also ignores the fact that Kansas, a state with a 100% trusting requirement, has a deficit of approximately $22 million (all of which is based on insurance-funded contracts).

 

Another explanatory note that may suggest that Missouri’s oversight is lacking is a note payable of $10 million owed by NPS to the Missouri preneed trust.  

 

Missouri’s Chapter 436 problems will not be fixed by going to a 100% trusting requirement. Oversight should be the state legislature’s top priority, and Missouri preneed sellers need to begin providing ideas and answers.  

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 While the completion of the document may have felt like a birthing process to the staff of Missouri's Division of Professional Registration, the Chapter 436 Working Group Recommendations more accurately reflects an industry position paper that has yet to be completed.   Faced with a deadline imposed by the Missouri legislature, the Division 'finalized' the Recommendations in an 11th hour meeting of the State Board of Embalmers and Funeral Directors.  The State Board meeting underscored that many industry members have yet to grasp how the preneed transaction is structured and administered by competitors.  This is best demonstrated by the State Board vote to revise the Recommendations to include the following:

 

·         The board recommended a 100% trusting requirement with no administrative or trustee expenses by a vote of 4-2.

 

 During various meetings, the issues of preneed sales expenses and trustee administration expenses having been erroneously interchanged by Committee members.  This confusion is due in part from Chapter 436 allowing all income to be distributed currently.  If the trust does not accrue income, the law requires the seller to assume responsibility for trust expenses.  Trustees normally look to trust income for administrative expenses.  If the trust has no income, the trustee is dependent upon the seller for reimbursement.  This aspect  compromises the fiduciary's duty to the trust. By its action, the State Board would perpetuate a major flaw in Chapter 436 (if trust funding is to survive at all). 

The State Board's objective is to protect the consumer, and to do so it must think comprehensively about the three forms of funding: insurance, joint accounts and trusts.   Is the consumer better served if trust funding is effectively precluded?   Of course not. 

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Mortuary Management’s July/August Colleague Wisdom column underscores how difficult it can be to run a trade association. I can empathize with the funeral home operators who took the time to provide their thoughts. As an attorney who specializes in the death care industry, I have to weigh the costs and benefits of membership in trade associations from two industries.

Every so often, the American Bar Association calls to solicit my renewal to the ABA. I was an ABA member back in 1986, the first year out of law school. After that first year membership, I never renewed again. Yet, they continue to call. And I will continue to decline, because the ABA is not a resource that is worth the cost (to me).   

  

In contrast, I do belong to the Missouri Bar Association.   The MBA provides services and programs that justify its membership costs to me. The MBA is not only a good source for forms and information, it provides some reasonable discounts for continuing education classes. However, I have not found that to be same for the Kansas Bar Association. The KBA seems to be marketing primarily to the trial attorney bar (a reflection of an economic reality).

 

If comments published in The Colleague Wisdom are representative of the funeral industry, the article reflects that funeral directors also tend to look more to their state association for the services and programs they need. It should come as no surprise but the level of satisfaction among funeral directors varies greatly. It is difficult to compare state associations because each has its own unique set of factors or hurdles. However, there seems to be certain common standards.

 

The Colleague Wisdom comments provide some insight to what industry members expect from an association, and why some do not participate. The comments also touch upon the revenues that subsidize the association. As Mr. Wigger so succinctly states: membership in a state association is a matter of weighing the costs vs. the benefits. One reality is that an association must impose costs in order to have the funds needed for programs and services that will attract membership. It is also a reality that some industry members will complain no matter what the cost. 

 

Some of the Colleague Wisdom comments have been highlighted in yellow, green and pink. The yellow comments seem to reflect an association’s perceived values. The green comments make note of a source of revenue, and the pink comments reflect criticisms. Associations need to be sensitive to criticism, and adapt to the membership’s needs. In order to do so, the association must seek input (even if it is done so by a coded survey). 

 

Now for the obligatory preneed comments:

 

Funeral directors who are opposed to preneed will need to appreciate that master trusts are an important source of revenue for association programs and organizational expenses. The master trust is an even more important revenue source for associations in states where continuing education is not required. But as one Colleague Wisdom commentator points out, association leadership must be careful with regard to the master trust becoming a competitor to its own members. In a sense, the master trust cannot help but be a competitor to larger independents that have their own preneed administration. The master trust may be the only way for the small operator to effectively compete for the preneed sale. Accordingly, it will become incumbent for association leadership to diffuse these situations through cooperation and attempts to find mutual benefits. 

 

Association leadership must also be careful that the master trust does not become a source of dissatisfaction when earnings and/or expense expectations are not met. Disclosures, accountability, frequent communications, innovation and leadership will be crucial to retaining membership satisfaction. 

 

With the NPS failure, associations may have an opportunity to expand their master trusts. But to do so, some state associations need to assess why funeral homes turned to NPS in the first place. Some funeral homes did succumb to the promises of profit, or looked forward to the Rep visit, but many did so out of dissatisfaction with their master trust. For some funeral directors (like those in Illinois), the state association may have a difficult task in regaining the membership’s faith.

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The American Funeral Director recently published Curtis Rostad’s rebuttal letter to a prior story titled “Debunking the Trust Myth”. That same story earned a post on this blog site. While I agree with Mr. Rostad’s views, the sad truth is that many death care trusts do not perform as well as the Indiana Master Trust. It speaks volumes when many Missouri funeral directors prefer insurance funding despite a state law that permits a 20% sales expense to be retained from trust funded contracts. While several reasons exist for the Missouri situation, expense, time demands, poor trust performance, and risk aversion are key factors. 

Until a critical mass is reached, death care trusts can be too expensive. Funeral directors are an independent lot, and most want to retain control of their preneed funds. (NPS will serve to reinforce this.) While pooling of preneed trusts would help address this hurdle, some state laws discourage the commingling of accounts because of the industry’s history of poor recordkeeping. 

 

Trusts require a commitment in time that many death care operators are often unwilling to provide. Fiduciaries need input from their death care clients about investment and compliance issues. Funeral directors and cemeterians are care-givers by nature, and many would rather delegate these responsibilities. In the absence of clear instructions, fiduciaries will default to more conservative investments.

 

It is difficult to provide quality asset management to small trusts. As a consequence, the small trust is often relegated to mutual funds or cash equivalents.   Even when the trust has sufficient assets to warrant a diversified portfolio, some operators are risk adverse and park the trust in conservative, but low yielding investments.  

 

Diversification is an important ingredient to improving trust performance. Today’s asset managers use diversification to guard against market risks, and to seek out growth and new sources of income such as dividend producing stocks.  To obtain the benefits of diversification, regulators and death care operators need to consider the economies of scale that pooled administration can provide. 

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If the President signs the Hubbard Act (H.R. 6580), the qualified funeral trust will have the capability to fund all of an individual’s final expenses. When enacted, Section 685 imposed a $7,000 cap on the preneed trusts that could elect special tax treatment. While the limitation increased annually, the cap was too low to permit funding of funeral and cemetery contracts. The cap also precluded cash advance related expenses from being included in many preneed contracts. The Hubbard Act may open the door to allow the Qualified Funeral Trust to become more of a final expense trust. 

The Hubbard Act would amend Section 685 for the 2009 tax year. We will need to wait for IRS guidance regarding any retroactive application of the amendment. However, the Hubbard Act would not impact the requirement that the trust must make a payout within 60 days of the beneficiary’s death.

It is interesting to note from the Congressional record that most trustees probably prepare the 1041 QFT without individual sub accounting. With regard to the Hubbard Act, the Congressional Budget Office reports that the Joint Committee on Taxation (the JCT) estimates the elimination of the QFT limitation will increase tax revenues $6 million over the next 9 years. This estimate is based on the assumption that trusts will produce more income that will be taxed at the higher rates. 

A 1041 QFT will be taxed at the lowest rate (15%) until its income exceeds $2,150. The next tax rate (25%) applies until the trust income exceeds $5,000. Assume the QFT maximum for 2008 ($9,000), and the trust has to have a return of nearly 24% before the second lowest tax rate is reached. If one were to assume the 1041 QFT has a trust of $25,000, the trust has to have a return of 8.6% (net of trustee fees).   Obviously, the JCT are looking at numbers that indicate that trustees are preparing the QFT without individual sub accounting. OUCH!

Assume a $3,000,000 preneed trust with 500 preneed contracts earns net income of 5%, or $150,000. With individual sub accounting, that trust’s 1041 QFT should have an approximate tax liability of $22,500. Without individual sub accounting, that same 1041 QFT will have an approximate tax liability of $51,543.50.   Even with the elimination of the Section 685 cap, the tax liability of the QFT with individual sub accounting will likely be taxed at 15%.   The difference equates to nearly 1% of the trust, or a good argument for better individual sub accounting.

The principal purpose of the Hubbard Act is to provide benefits to the survivors of soldiers killed or severely injured.   I doubt it was coincidental that taxes from preneed trusts will be used to offset the costs of helping a soldier’s survivor build a new life.

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In response to a proposal that preneed trustees be required to provide periodic account statements to contract purchasers, a funeral director asked what liability he would have to consumers who question the trust’s performance during a year such as 2008.   Legally speaking: none. But ultimately, death care companies should be accountable to their families for the decisions they make with regard to preneed funds, including where those funds are placed and how well they are invested. With regard to certain contracts, NPS providers may not be responsible for the promised funeral, but consumers will punish the funeral home that turns its back on those contracts. The funeral home put the consumer at risk by agreeing to do business with NPS. Similarly, if a funeral home fails to devote the time and resources required for proper management of its preneed trust, consumers should ask if they are assuming too great a risk that the facility will be in business when the funeral is needed. 

Realistically, periodic trust statements to individual purchasers provide a ‘tickler’ that alone will not flag a troubled preneed program. A systematic trust reporting system is needed. Such a trust reporting system must also afford the public sufficient information to assess the financial strength of the preneed program. Yes, there will be a cost to both consumer and the funeral home, but a trust reporting system will reward the funeral home that devotes the energy and resources required to properly administer their families’ preneed funds.   

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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. 

While it does not come as a surprise that prosecutors from Michigan and Tennessee are looking at these connections, other states may also be conducting related investigations.    

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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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A year ago, the Dayton JournalNews ran a series of articles about the regulation of the death care industry in Ohio.   The reporting was comprehensive, with articles about preneed.  Earlier this year, legislation was introduced in Ohio to further restrict who could sell preneed.  However, the legislation does not address the trusting issues that rankle consumer advocates.  That bill was approved by the Ohio Senate, and will be considered next by the House.

Some of those same issues will be brought front and center in Jefferson City, Missouri when hearings are commenced on the reform of Missouri's preneed law on July 8th.  A full discussion of all the issues would benefit consumer advocates, regulators and the death care industry.

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The class action lawsuit brought against the NPS affiliates on Friday, June 20^th reflects the despair that some funeral directors are experiencing over the situation. Although litigation to recover assets from the Cassity Empire was inevitable, this lawsuit has flaws that need to be corrected through an organized effort brought by the states’ regulators.

Funeral homes have a legal claim for damages against NPS to the extent they have serviced NPS contracts and failed to receive the compensation promised them by NPS. Consequently, I anticipated finding this provider’s associate agreement as an exhibit to the pleading. However, the filing omitted documentation that would evidence the funeral home’s rights and obligations with regard to the performed contracts and the contracts that remain to be performed. As evidenced by the June 9^th Funeral Service Insider, NPS played by fast and loose rules when it came to their relationships with provider funeral homes. So, what are funeral homes entitled to?

The lawsuit also fails to include the consumer as a member of the plaintiff class. With regard to executory preneed contracts, the consumer has superior rights to the funeral home. Ignoring the rollover contracts, the funeral home has an expectation of performing the preneed contract when the death occurs. However, the consumer could always move to another state, or cancel the contract. Until the funeral is provided, it is the consumer who has the greater claim of damages from NPS. His/her NPS contract has no cancellation value or portability. 

The lawsuit is also troubling in the sense it presumes that whole life insurance policies were appropriate trust investments under Missouri’s preneed law. Chapter 436 is a bit ambiguous about insurance funded contracts, but with regard to trust funding, the law permits the preneed seller to retain 20% of the contract’s purchase price, and to trust the remaining 80%. Unless the purchaser makes the contract irrevocable to qualify for public assistance, the contract can be cancelled and the seller must refund the amount that went into trust. So, if the seller trusts only 80%, how can the trustee purchase a whole life policy and have the liquidity required for Chapter 436 compliance?  

This funeral home points an accusing finger at the fiduciaries, but the pleading reflects the funeral home’s acceptance of the trust holding whole life insurance. A question regulators might ask is whether the funeral home received any compensation for the insurance purchased by the trust. 

Regulators have valid excuses for distancing themselves from this lawsuit, but consumers need an independent authority pursuing their (and funeral directors’) claims against NPS.   If regulators do not recover sufficient assets, funeral homes will fail and consumers will lose their funeral promises.  

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On June 11^th, Senator Delbert Scott met with a number of death care industry members and regulators to begin mapping out the direction for preneed reform in Missouri.  From that meeting, it was decided that the state’s death care regulators would form review committees that would facilitate a dialog on the issues, and help formulate recommendations for the Missouri Legislature’s Joint Committee on Preneed Funeral Contracts. The Joint Committee is expected to begin hearings in September.  

The State Board of Embalmers and Funeral Directors has formed its Chapter 436 Review Committee, with the first meeting scheduled for July 8th. The Office of Endowed Care will defer formation of its review committee until later in July. The Chapter 214 Review Committee will not meet until August, after the Chapter 436 review committee meetings are concluded. 

To provide some structure for the Chapter 436 meetings, the State Board is circulating a survey on 67 issues. The review committee meetings will have to maintain tight schedules in order to adequately address those issues. The review committee meetings will provide public attendees an opportunity to provide comments. 

It will be crucial that consumers, funeral directors, cemeterians, fiduciaries and vendors contribute to the discussions that will take place at these meetings. 

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In what may prove to be a lengthy legal proceeding, Missouri Attorney General Jay Nixon filed suit against Forever Network, Inc., an affiliate of National Prearranged Services (NPS).  While the suit may duplicate the injunctions effected by the Agreed Order obtained by the Texas Department of Insurance, consumers should take comfort by the fact Mr. Nixon has begun taking action.  

While it may be days before a copy of the petition can be obtained for review, I anticipate the pleading may share some of the same assertions and requests made by Texas.  While this duplication may be confusing to funeral directors, the difficulty regulators face in bringing proceedings against NPS is that each regulator must establish the requisite authority for the remedies sought.   For Jay Nixon and the Missouri State Board of Embalmers and Funeral Directors, Chapter 436 is full of ambiguities, making their case against NPS challenging (but not impossible). 

The Missouri regulators have a stated goal of ensuring that consumers receive the services they have paid for.  While Chapter 436 has its many faults, regulators should keep in mind Section 436.007.2, which provides:

If a preneed contract does not comply with the provisions of sections 436.005 to 436.071, all payments made under such contract shall be recoverable by the purchaser, his heirs, or legal representative, from the contract seller or other payee thereof, together with interest at the rate of ten percent per annum and all reasonable costs of collection, including attorneys' fees.

NPS aggressively marketed preneed contracts on an installment basis that incorporated vague finance charges and “premature death discount fees”.  These charges often drove the price of the preneed contract up by thousands of dollars.  Justice would taste sweet if the Cassitys' had to give it all back.   

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Preneed companies often reach too far in touting the advantages of their company or product. Such is the case with an article in the June edition of the American Funeral Director. Not to be confused with the infamous Lincoln Memorial Life, Lincoln Heritage Life offers advice why insurance funded preneed is often a better choice for funeral directors and consumers. While the author is correct about there being advantages to the insurance funded product, the article makes several gross generalizations and neglects to address the disadvantages of insurance. The timing of the article couldn’t be worse with the evolving NPS/Lincoln Memorial Life scandal. 

Preneed companies should know better than to make such generalizations. State laws regulate the preneed transaction, and so long as this remains true, the wide variance in these laws precludes simple generalizations.   Preneed laws are confusing, and often contradictory.   Preneed companies should resist giving consumers and funeral directors an impression that is otherwise. Funeral directors are not children, so drop the condescending analogies to the Cookie Monster.   Insurance doesn’t mysteriously create two cookies.

Purchaser payments are used by the insurance company to pay commission, administration, contract forms, state insurance department filings, advertising, taxes, actuary salaries, marketing expenses, and reserve requirements. The insurance company overhead results in a low cash surrender value for the older consumer. The older the consumer, the higher the mortality risk. The higher the mortality risk, the more the insurance company has to charge for the insurance policy purchased with installments. The preneed consumer in his/her 70’s may end up paying premiums that exceed the policy death benefit.   

Under given facts, the insurance policy will out perform a trust. For the preneed contract that has a duration of ten or more years, the properly managed trust often outperforms the insurance product. How does the article’s analysis hold up for the trust that averages 6 percent after taxes and expenses? The problem is that many trusts are not managed well, and the investment return may be the low 4 percent the author describes. Small preneed trusts are often ‘parked’ in mutual funds or government securities.     

What about those licensing requirements? Maintaining individual life insurance licenses can be burdensome for funeral directors. With the NPS/Lincoln debacle, the industry will likely see states pass tougher laws on who can sell insurance. After all, the NPS/Lincoln crisis is as much an insurance problem as it is a trust problem. As the article suggests, funeral directors should look closely at the insurance company’s history and financial strength.   Also consider the ‘associates’ that the insurance company retains. For those NPS providers looking for a new insurance program:  

"Fool me once,
shame on you.
Fool me twice,
shame on me."

--Chinese Proverb

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Funeral directors will attempt to leverage the Funeral Service Insider’s report about the NPS contributions to state politicians, but they should do so with caution.

The story does not paint the entire picture of NPS’ efforts to influence the politics that controlled Missouri’s preneed industry. The amount attributed to the Missouri efforts ($168,000) seems low. Granted it does not reflect contributions made during the past two years, or those made prior to 1999, but the seven years in question cover the period when NPS’ sales seemed to have leaped (within Missouri and to other states). 

If NPS providers are going to point an accusing finger at Jay Nixon, they need to consider two issues: their need for Nixon’s help and cooperation, and the complicity of some funeral directors in the NPS impropriety. 

NPS made political contributions for a number of reasons, including the opportunity to have NPS providers appointed to the Missouri State Board of Embalmers and Funeral Directors. The funeral homes demanding action from the regulators may, for the most part, be innocent.  But when a group is found to have one or more pots calling the kettle black, the credibility of the group as a whole is undermined.

If it is not apparent, there is some finger pointing being done within the regulators’ closed circle. A potential issue in the rift among the regulators maybe the political dispute between Missouri Governor Matt Blunt and Missouri Attorney General Jay Nixon that prompted the AG’s Office to pull its staff attorneys from their day to day representation of the various state boards and agencies. This forced the Missouri State Board of Embalmers and Funeral Directors to look to the legal staff of the Division of Professional Registration, a staff that was already stretched. In reality, the NPS situation existed long before the AG pulled its attorneys, and the posturing has already begun for that issue.  

The NPS meltdown has regulators scrambling for their respective excuses. Some of those excuses will appropriately lay the blame back on the death care industry. However, NPS was an equal opportunist when it came to exploiting politicians and funeral directors. Eventually many individuals may be called upon to provide an explanation, but funeral directors and regulators would be better served channeling their current energies towards the recovery of consumers’ funds and the formulation of a program to administer those funds.  

In five months, consumers will be voting.  Will they be more receptive to excuses or explanations about the efforts already implemented to provide their funerals?

Everyone has an excuse. Write them down and put them away for another day.  

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The Cassitys have a rearguard strategy after all.

The Texas Department of Insurance paid a price for gaining control of NPS and its sister insurance companies: A Rule 11 Agreement.   Texas has agreed to not bring litigation against the companies, or various individuals and firms related to NPS.  A very steep price, but one Texas may have felt it had to pay in order to gain control of the NPS/Lincoln records. 

The $640 million question is who will pursue the Cassitys if the NPS cupboard turns out to be bare? 

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As news of the NPS meltdown began to leak last month, several proposals to reform Missouri's preneed law were hastily drafted.  Not knowing the extent of NPS' problems, some reform advocates felt the need to strike while the iron was hot. 

Even as the legislative session ended on May 16th, it was not clear whether any reform would be enacted.  However, when the dust settled in Jefferson City, the only preneed reform enacted will prove the most prudent.

By virtue of an amendment made to Senate Bill 788 on the Senate Floor, the "Joint Committee on Preneed Funeral Contracts" was given birth.  The committee will be formed with seven members from each of the House and the Senate. 

The Joint Committee's tasks are to:

(1) Make a comprehensive study and analysis of the consumer and economic impact on the preneed funeral contract industry in the state of Missouri;

(2) Determine from its study and analysis the need for changes in statutory law; and

(3) Make any other recommendation to the general assembly relating to its findings.

By the time the Committee members are appointed, and hearings are scheduled in September, a great deal more will be known about NPS' business practices.  However, the hearings are bound to put Missouri's entire preneed industry under the microscope.  The death care industry has the summer to prepare.

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One positive aspect of Texas appointing a “Rehabilitator” for NPS and its sister insurance companies is the emergence of a single authority over the NPS empire, a godfather so to speak. Rather, a Godmother.

Funeral directors have been chasing legislators, regulators, government officials, and judges for help. This is quite understandable when your entire preneed program was with NPS. However, the Agreed Order Appointing Rehabilitator and Permanent Injunction (“Agreed Order”) will stay all lawsuits like that brought by the Broussard’s Mortuary, a long established Texas company. 

The Agreed Order could also bring much needed focus for groups like the “Consumers Funeral Assurance”, a Missouri outfit that is soliciting support from former NPS providers. (Have you spoken with Josh about the similarities in your names? )

One valid grievance funeral directors have with the regulators’ current status quo is the payment of claims based on the contract’s sales price.   For NPS contracts sold within the past few years, the contract face does not represent much of a hardship. It will be quite a different story for the twelve year-old contract.   Now we can appreciate why NPS was offering those Triad casket coupons.  

Rather than pursue geese like the “formation of a quasi-state agency that will assist with the payment of claims”, funeral homes (or the entities that form to represent them) should channel their energies and resources towards the inclusion of their issues in the plan of rehabilitation required by Texas law.   (See ¶2.11 of the Agreed Order.) 

While funeral directors may be tempted to seek an appointment with Ms. Garrett, they would be better served by briefing the issues for her consideration. Funeral directors should be objective and honest in how they present their issues. Ms. Garrett will be taking possession of all NPS records, and ostensibly, will discover which funeral homes received loans or special commission payments. The emperor has no clothes.  

It would also be advisable to tone down the rhetoric. Regulators are probably beginning to appreciate their responsibilities for the NPS failure, but are the funeral directors? 

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The dominoes are beginning to fall.  The Texas Department of Insurance has disclosed that Lincoln Memorial and its sister Memorial Service Life have been put into receivership.  The Department's website provides a copy of the order appointing a Donna J. Garrett as the companies' rehabilitator, and a Q&A for consumers. 

 

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Yesterday, the St. Louis Post-Dispatch ran an article that examined the history of NPS, and raised some of the questions that need to be explored in depth in the months to come.   The system failed in several states, for both consumers and funeral homes.   While most funeral homes will try to make good on the NPS promises to consumers, regulators must share in the responsibilities for what went wrong and what has to be done.

NPS was an innovative company that grew frustrated with the fragmented nature of state preneed laws, and exploited the gaps and ambiguities of state regulation.   Some will say that NPS exploited the greed of funeral directors, and this should be sufficient reason for holding funeral homes responsible for performance of the NPS contracts. While this will ring true for some funeral directors, this is too simplistic an explanation of the situation.   The reality is that many funeral homes will fail if regulators do not recover sufficient assets from the Cassitys. 

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The Missouri preneed industry faces a long and stormy summer. 

The Missouri legislature seems to be listening to regulators' requests for much needed authorities for examinations, audits and rulemaking.  A draft bill providing emergency powers to the Division of Professional Registration has emerged as legislation that may be signed into law before the current session ends next week.  In contrast to most bills enacted into law, this one is rumored to have an immediate effective date.

If the bill is signed into law, the Missouri State Board of Embalmers and Funeral Directors will begin to study methods for implementing the preneed inspection powers to determine whether the state's preneed problems extend beyond the NPS failure.  Though meant to demonstrate the industry's overall compliance with Chapter 436, recent testimony at legislative hearings may have undermined regulators' confidence in the industry's past efforts to comply with current law.

One approach the State Board will consider is a comprehensive desk top examination of each seller's fundamental compliance with Chapter 436.   Approximately 12 years ago, the State Board contemplated a broad based review process that  would have sought basic information about the three methods of funding: trust, insurance and joint accounts.   However, the initiative could not be pursued because the State Board lacked the authority to require compliance by licensees. 

I could not attend recent  a hearing where industry members testified before legislators to provide assurances that most funeral directors do comply with Chapter 436.  If the description provided to me about the testimony of one well intended funeral director was accurate,  funeral homes need to take a refresher on the requirements of Chapter 436.  I have heard similar misstatements by funeral directors at recent State Board meetings.

I anticipate that The Missouri Funeral Directors and Embalmers Association is already working on Chapter 436 compliance courses to provide its members.  Association members would be well advised to take such a course before assuming their funeral home is in compliance.

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On Wednesday, April 30^th, the Missouri Department of Insurance fired off the first salvo in the legal proceedings to recover funds from Lincoln Memorial Life Insurance Company. In an effort to prepare those affected by the NPS meltdown, the Missouri State Board of Embalmers and Funeral Directors and the Division of Professional Registration have issued press releases that explain critical issues related to this situation. The tenor of these press releases is substantially different from those previously released by other states’ regulators. Consumers and funeral directors need to review these releases carefully.   

If it hasn’t been apparent to funeral directors before now, Missouri’s filings against Lincoln Memorial Life reflect that the NPS trusts are full of term insurance policies. Some reports indicate that the policies may be lapsing soon. While Missouri Department of Insurance has filed its actions against Lincoln Memorial Life, the eventual target will be the NPS/Lincoln corporate officers and directors. Because regulators must pursue their claims through the authorities granted by the statutes governing insurance and preneed, funeral homes need to consider banding together in an action that focuses on the authorities granted to the replacement management team installed by the Texas regulators. 

The Missouri regulators and their legal staffs have been overwhelmed by the situation.   These offices were understaffed to begin with, and the magnitude of the investigation, legal proceedings and inquiries has stretched their resources to the limits. This all may make for good campaign rhetoric in the upcoming fall elections, but the industry needs to take actions to help recover improperly diverted funds. 

The rumors of law firms offering to initiate class action lawsuits have already begun to circulate. But, most funeral directors probably appreciate that building a coalition to preserve the NPS assets and working towards an equitable division of the proceeds would better serve their interests.   To be fair, consumers need an explanation about the third party preneed transaction and their exposure for the NPS failure. 

The majority of preneed contracts are between the funeral home/cemetery and the purchaser, wherein the funeral home/cemetery is the primary obligor. The essence of the contract is two promises: the purchaser to pay a specific amount of money and the funeral home/cemetery to provide certain described services and goods when the purchaser (beneficiary) dies.   

NPS is (was) a third party preneed seller. Funeral homes and cemeteries use third party sellers for a handful of valid purposes. Often, smaller death care companies may not have the volume of preneed sales to justify the expense of contracts, administration and compliance and so they contract with third party preneed sellers. Some states require the death care company to be the obligor of the preneed contract, but many do not. In states where law requires the death care company to be the obligor, the third party seller acts in an agency capacity to the funeral home and cemetery. It that situation, the death care company has an obligation to honor the contract regardless of most circumstances (like the failure of the trust). 

However, states such as Missouri and Texas, allow the third party seller to be the obligor of the preneed contract. In these types of preneed transactions, there are four sets of promises: the purchaser to pay money to the third party seller, the third party seller to cause the funeral home to provide a funeral by paying it money, the funeral home to provide the funeral, and the third party seller to pay money to the funeral home. However, the terms of the payment between the third party seller and the funeral home are not generally disclosed in the preneed contract, but rather in a separate agreement between the third party seller and the funeral home/cemetery (called an associate agreement or provider agreement). 

NPS used a multitude of different preneed contract forms and associate agreements (most of which were infamous for their ambiguity or brevity). NPS relied upon these ambiguities to transfer preneed contracts from one funeral home to another funeral home if the circumstances benefited NPS. Consequently, the agreements were intended to be difficult to enforce, which cuts two ways.

Regulators did not seem to appreciate this fact when early press releases were issued to calm consumers. Those press releases suggested that funeral homes would have to honor their NPS contract “pursuant to their terms”.   While funeral directors cannot afford to walk away from their families, regulators need to follow the lead taken by Missouri’s State Board of Embalmers and Funeral Directors by being more forthright with consumers.   If the NPS/Lincoln proceedings take years to resolve (instead of months), the parties will need an understanding of their respective rights and obligations in reaching fair and equitable settlements.

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With two reform bills (HB 2469 and HB 2594) already introduced into the legislature, and two substitute proposals in the works, Missouri legislators and regulators are committed to fixing a law that allowed NPS to exploit consumers and funeral homes. However, consumers and the death care industry are both having difficulty analyzing the specifics of the various proposals. The haste with which legislation is being pressed suggests that regulators know more about the gravity of the NPS situation than what has been disclosed to the public.

Chapter 436 has some obvious problems:

• The combination of a low trusting percentage (the last 80% of payments) and the right to withdraw income currently

• Restrictions on the state board to order inspections or audits

• Minimal reporting requirements

• Ambiguity regarding deposit requirements

• Ambiguity regarding insurance funded preneed

• A lack of rulemaking authority

• An underlying assumption that all preneed contracts will be price guaranteed, and most would be trust funded

• Inadequate provisions for consumer protections when sellers or providers go out of business or are sold

• A general lack of independent oversight

What may not be apparent to legislators, and to consumers, are the many competing economic interests that exist under the “death care” umbrella. There is little doubt that legislators are getting a crash course on those interests. The various proposals already reflect certain interests of regulators, funeral homes and preneed sellers. But if legislators are only now learning the issues, how will they know which proposals are in the best interests of the consumer?

If it were not for the NPS meltdown, Chapter 436 would not be a topic of discussion in Jefferson City. Last year, Representative Meadows proposed a reform bill that was blocked before it could even be discussed. The year before, the State Board of Embalmers and Funeral Directors put preneed reform on its agenda, but the chairman, Ken McGhee, received very little support, or interest.  The sudden interest to fix Chapter 436 is being driven by the NPS failure.

Preneed is a complex issue, and Chapter 436 has more faults than most states’ preneed laws. But, the NPS situation cannot be fixed if we do not know the extent of the damage. It is too late to close this barn door. Rather, the legislature must bring structure to a situation that has many competing interests. The NPS meltdown is unprecedented, and a public forum is needed so that all can understand what went wrong, and where should we go from here. 

With regard to drafting preneed reform, the Missouri death care industry has historically relied upon representatives from the State Board, the funeral directors association, the cemetery association, preneed sellers and the consolidators to forge a consensus bill to submit to the legislature. This group has been referred to as the Allied Council. It has been 13 years since the Allied Council forwarded a Chapter 436 proposal to legislators. Ironically, that Allied Council effort was subverted by NPS. 

Chapter 436 will be revised. However it should be done with the input of an Allied Council that includes consumers, insurance companies and the attorney general’s office. 

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Certainty? In this world nothing is certain but death and taxes.

Benjamin Franklin

The “collapse” of National Prearrangement Services comes as a shock to both the company’s clients and competitors. For the seventeen states in which NPS transacted business, regulators are scrambling to get their arms around the magnitude of the problem. NPS’ adversarial reputation will cause many regulators to move cautiously. However the capitulation by NPS to the termination of its marketing operations should cause regulators to consider whether the individuals that control NPS and its related sibling corporations have employed a rearguard strategy.

Missouri and Texas will figure prominently in regulators’ efforts to protect consumers. NPS maintains its corporate headquarters in St. Louis, Missouri.   The insurance company to which NPS funnels its preneed sales, Lincoln Memorial Life, is a Texas company located in Austin. Accordingly, records of NPS’ preneed sales should be in St. Louis and the funds received by NPS should (hopefully) have made their way to Austin, and subject to the jurisdiction of the Texas Department of Insurance (TDI).  

However, the news from TDI has been a bit confusing. On April 9^th, TDI issued a press release that disclosed that an Agreed Order had been entered into with NPS. The press release states:

The TDI-issued Hazardous Financial Condition Order requires the companies to establish a plan to pay policyholder claims and to address existing contracts.

"While every effort was made to secure the companies and return them to normal operations, the decision was made to take this regulatory action," said Texas Insurance Commissioner Mike Geeslin. "As we move forward, our goal is to use every law on the books to protect consumers, coordinate with other regulators and states and - most importantly - keep all parties informed as issues develop."

"It is imperative that we work closely with NPS and the funeral providers to ensure all Texas consumers receive their prepaid funeral goods and services as originally promised," said Texas Banking Commissioner Randall James.

For years, these companies have been dependent upon new sales (and trust transfers) for revenues to meet promises made to funeral homes. Consequently, TDI’s assurances about returning these companies to ‘normal operations’ rang hollow when news of NPS’ termination of its sales personnel was leaked. A day later, the Kansas City Star reported that a Kansas lawyer had taken “control of the company Tuesday as action manager of behalf of Texas,…”    So, what is going on? 

The lawyer referenced by the Kansas City Star article has experience with insolvent insurance companies, and so one explanation could be that Texas is preparing to take control of Lincoln Memorial Life. 

With NPS being deprived future sales, the Lincoln Memorial assets may be the only source of payment for hundreds of thousands of consumers. Texas reported 39,000 policyholders, and Missouri reported 46,000, and while these two states may account for a substantial portion of NPS’ business, there are 15 other states with NPS sales.

 With information in such short supply, one must be careful not to read too much into these press releases. But each seems to place emphasis on “Policies” and “Policyholders”. There seems to be an assumption (or at least a hope) that each NPS sale ended in a Lincoln Memorial policy. Yet, many of us know that NPS aggressively pursued trust rollovers that included questionable records for the preneed contracts involved. With regard to those transactions, it is unlikely that purchasers were ever contacted. The question then becomes what NPS/Lincoln did with the funds from their trust rollovers? 

To know just how deep the NPS waters are, Missouri is key to obtaining NPS and its corporate records. On April 9^th, the Division of Professional Registration issued a press release that advised:

Funeral directors are cautioned to ensure they maintain adequate records and evaluate any preneed arrangement sold on behalf of their funeral establishment.

On April 11^th, The Kansas City Star reported the following comments:

“We want people to know we are working to safeguard their interest,” ……….. “We’ve stopped the flow of business to look at what’s going on. Our concern is that they get what they paid for.”

While terminating NPS’ authority to enter new transactions had to be its first priority, Missouri must now determine how it can best protect all consumers, not just those from Missouri. If there is any doubt about the trust rollover transactions, Missouri needs to take prompt action to secure NPS’ corporate records. 

Which brings this post back to its introductory muse: has NPS been sacrificed as some sort of rearguard maneuver?  

We can hope that NPS will take all actions necessary to provide assurances to its policyholders, including cooperation with Missouri’s regulators. But if push comes to shove over records that document the company’s money trails, NPS may resort to its true colors when responding to Missouri’s requests. Funeral directors must prepare for that potential conflict.

All funeral homes that have NPS contracts should begin an inventory of their paperwork.   For funeral directors that participated in an NPS trust rollover, the inventory should include documentation regarding the application of the trust funds. If their records do not include such documentation, funeral directors need to consider making an immediate written request to NPS. An even tougher (but necessary) decision may be whether to copy that request to your state preneed regulator. 

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A bank client recently asked that I provide some standard of accountability for administration provided to a master preneed trust. As I struggle to provide the client a concise answer, I can’t help but to think that the issue will also become a crucial concern to consumers and funeral directors alike. As news reports reach consumers about the regulatory actions taken against the preneed programs maintained by NPS and by the Illinois Funeral Directors Association, families will begin to contact their funeral directors for reassurances about their preneed payments. Unfortunately, many state associations have not made accountability a priority, and their members may be ill prepared to respond to consumers’ concerns. 

For the independent funeral home, the state association can be a valuable resource to understanding the requirements imposed upon the profession by federal and state laws. As the preneed transaction grew in acceptance, most state associations formed master trusts to serve their member funeral homes.   These master trusts came to reflect not only the respective state’s preneed law, but also the attitudes and values of the association leadership.

Consumers need to appreciate that master preneed trusts are an important source of income to the sponsoring association. Because there are costs to providing contracts, administration, compliance, and asset management, the master trust provides the smaller funeral home the economies of scale necessary to reducing costs that would otherwise be prohibitive. However, the Illinois situation suggests that former association leadership may have exploited both members and consumers. While the association’s website is finally acknowledging the issue, the response lacks in terms of accountability. 

Getting back to my client’s question, how should accountability be measured for preneed administration from state to state? The diversity in the approaches taken by the state legislatures in regulating the preneed transaction is the single greatest hurdle to a comprehensive, national evaluation of preneed accountability. But perhaps transparency in terms of disclosures to both members and consumers would be one measure of accountability. On this standard, I would give kudos to the New Jersey Funeral Directors Association. It may be a sad reflection on the industry, but many funeral directors do not know what they are being charged for preneed services. The NJFDA provides this information for all to see.

If consumers do call for reassurances, funeral directors should have some basic information available to provide:

• How the preneed contract is funded (insurance vs. trust).
• The name of the insurance company or trustee.
• If the contract is trust funded, whether the trust holds deposit accounts, investments dictated by statute, diversified investments or insurance.
• Contact information for the person who can provide more information about the account.

When funeral directors begin to call for reassurances, association leadership should be prepared to provide the following information:

• The name and address of the trustee.
• The costs and expenses of the master trust.
• The master trust’s written investment policy.
• The fees paid to the trustee and account administrator.
• 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.)
• A summary of all trust expenses (excluding distributions for preneed contract performances and cancellations).
• The sponsorship fee paid the association. 

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NPS, beleaguered by state regulatory proceedings in Kentucky, Illinois, Ohio, Texas and Iowa, has called it quits. 

 

NO MAS! 

 

ENOUGH! 

 

Much to the surprise of industry leaders, NPS has suggested it will do what's in the best interests of the consumers.  Could this mean a refund to everyone?

 

April Fools Day!  

 

If anything, NPS is a fighter, and will battle each of these states.  Does NPS have problems?  Sure.  The insurance in the trust scheme has had competitors mad for years, and for good reason.  Does NPS' problems make it vulnerable to the funeral homes it contracts with?  Better go read those associate agreements.   The Funeral Service Insider suggests funeral homes could be taking the hit if NPS fails.  That may not be the case.  Nor is FSI's source on point when suggesting that the purchaser money that NPS collects is also the funeral home's money.   Funeral directors need to start reading those NPS contracts to determine if they are an 'obligor'.   Frequently, NPS associates are agreeing to provide the described funeral when they are paid pursuant to the terms of the agreements (note: plural..... agreements, you need to read more than the preneed contract). 

The consumer is the one most exposed by a possible NPS failure.  And if that were to happen, it would also be catastrophic to the industry's integrity, and the arguments against federal regulation.

But, it is a little early to be giving NPS any final rites.  Industry leaders need to take a calm approach to the situation, and avoid contributing to the rumor mill.  Consumers need to contact their state regulators to obtain more information about the safety of their funds.  Funeral directors need to get out those associate agreements, and begin to read.

 

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The preneed bill that angered the Funeral Consumers Alliance in February continues to advance within the Tennessee legislature. SB 2705/HB 2763 has been placed on the calendar for the Commerce Committee for April 1^st. If passed, the legislation may well make Tennessee the first state to lower its preneed trusting requirement. Despite the need for better consumer protections, I anticipate other states may eventually follow suit. 

Preneed is evolving from a transaction of accommodation to becoming an essential element of each funeral home’s business. Funeral directors in 100% trusting states such as Tennessee are feeling the need to control their own preneed programs, and have come to appreciate the costs of establishing, and maintaining, a trust funded preneed program. 100% trusting laws have historically dictated that insurance be used as the principal method for funding, with trust funding as a backup for purchasers who were too old or could not qualify. With insurance companies coming and going within the preneed market, funeral homes want the alternative to offer consumers a trust-based product.

Why will legislators be willing to decrease 100% trusting laws: the guaranteed preneed contract has been, and continues to be, viewed as a sale of goods and services. Legislators are likely being told that if consumers want a product that provides a full refund right, and portability, then they can choose a non-guaranteed preneed contract. Tennessee’s law provides that option. But is the non-guaranteed preneed contract really a viable alternative?

The vast majority of laws and regulations aimed at regulating the preneed transaction are in response to the guaranteed preneed contract. This is true regardless of whether the issue is securities regulation, income taxes or trusting requirements. Preneed has been defined as a purchase transaction, not a dedicated savings account transaction. As a consequence, criticism that attempts to re-characterize the preneed transaction as a savings plan can often be deflected by the death care industry. 

The Tennessee Prepaid Funeral Benefits Act has several excellent features, and could serve as a reference for other states. But, as with most preneed laws, it has some provisions which leaves one to scratch his or her head (like Section 62-5-408(d)). Yet, SB2705/HB2763 provides a reasonable remedy to the hole left in the 2007 effort to repair the Smart damage: funding the protection fund from the funds retained by sellers on guaranteed preneed contract sales.  

Fiduciaries also need to consider that the Act authorizes civil penalties of up to $1,000 for each violation of the Act committed by the preneed trustee. 

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It's always an ugly scene when a party to a fiduciary relationship gets caught with his/her hand in the cookie jar.  Unfortunately, this has been happening with alarming frequency in the death care community, and Indiana has had enough.  In a relationship that requires mutual cooperation, the death care industry has taken the position that "someone should have stopped us by saying no", and the Indiana legislators have agreed.   With the legislation signed into law last week, Indiana has initiated a major shift in the responsibilities of the death care fiduciary.  Like the tree falling in the forest, was there anyone from the banking/fiduciary community around to here it?

The Indiana legislature moved quickly in response to the trust frauds committed at Grandview Memorial Gardens and at the cemeteries owned by Robert and Debra Nelms, and Governor Daniels followed suit by signing HB 1026.  The new law will go into effect July 1, authorizing the Indiana State Board of Funeral and Cemetery Service to promulgate regulations that will determine the distribution documentation that must be reviewed and approved by death care fiduciaries.  Failure to comply with these new requirements will expose the fiduciary to criminal charges and liability to cemetery customers. 

 To understand the gravity of the issue, fiduciaries need not go any further than their clients for input.  The general counsel for the Indiana Cemetery Association put it this way:

The people who own the trusts could do almost what they wanted. We've given the trust companies the incentive not to pull the wool over their eyes.

Cemetery association members were aghast to learn of the case because they did not understand the extent that the current law left cemetery trusts vulnerable. People really weren't aware. 

It would be safe to say that most death care fiduciaries are still unaware how vulnerable these trusts are.

What should death care fiduciaries do?  The knee-jerk reaction would be to terminate such accounts and run as far away as possible.  However, the fraudulent character of the charges leveled in recent class-action suits bring into question whether the statute of limitations has even begun to run.  The class-action lawsuit brought on behalf of Grandview Memorial Gardens lot owners will likely turn on whether preneed contracts were performed pursuant to their terms, and that will require the distasteful act of opening gravespaces.  The trust frauds committed by the Nelms have already snared one fiduciary and a major brokerage firm when a $20 million class-action lawsuit was filed in late January on behalf of cemetery lot owners. 

Fiduciaries with a federal charter may be tempted to play the federal preemption card that has been used to keep state regulators at bay with regard to the sub prime mortgage crisis, but history is not on the national fiduciary's side with regard to death care regulation.  State death care regulators in Florida and Texas have taken OTS preemption opinions, rolled them up and slapped thrift chartered fiduciaries into submission.  Frankly, the legal arguments advanced by the state regulators were on point.

Indiana chartered fiduciaries need to become engaged in the procedures that will be unfolding before the Indiana State Board of Funeral and Cemetery Service later this Summer.  The death care industry will be there in force providing their comments about the forms and procedures to be covered by the regulations authorized by the new law.  Fiduciaries will have no one but themselves to blame if they miss this dance. 

Federally chartered fiduciaries will need to determine how significant a block of business Indiana represents to their death care business.  These fiduciaries will also need to monitor other states to see whether the Indiana law represents a trend that other state legislatures will follow. 

Death care companies and consumers will need to anticipate an increase in the cost of fiduciary services.   The old adage "you get what you pay for" has a double-edged application to the death care fiduciary environment.  The security sought by consumers and cemeteries/funeral homes will come at a cost.  To minimize the cost of the new obligation to provide distribution oversight, death care companies and fiduciaries will need to explore standardized examination procedures or the reliance on established audit procedures.   Death care companies will also have to be more receptive to trust instrument provisions intended to provide fiduciaries the power to say no, and protections when they do.

 

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It must be spring: preneed reform bills are sprouting like crocus. 

 

The direction taken by the Maryland and Tennessee legislatures in proposing protection funds drew recent criticism from the Funeral Consumers Alliance. While consumer advocates have some valid points regarding these legislative efforts, the obstacles facing states are far more complex than what most outsiders understand. For purposes of this blog entry, lets focus on Maryland and put Tennessee off to another day.

 

First, a distinction needs to be made between a state’s industry board and a state trade association. Some times the two cooperate to get legislation introduced and passed, and then sometimes the two are on very different pages. Most state industry boards are understaffed and under funded. A casual survey of the website for the Maryland State Board of Morticians & Funeral Directors reflects the Board has one inspector, excuse me, had one inspector, for all of the state’s funeral homes.   While the Board’s principal purpose is the “protection of the public's health and welfare through proper credentialing, examination, licensure, and discipline of morticians, funeral directors, surviving spouses, apprentices and funeral establishments in Maryland”, its newsletter suggests preneed has become its pressing problem.

 

Preneed accounts for most of the Board’s complaints, and the number of funeral homes that are late in filing their reports to the Board are substantial. Yet any thoughts the Board may have regarding enforcement actions must be tempered with the realities of its budget. As a self-supported entity, the Board’s resources are those fees it charges the state’s funeral homes and morticians, and there lies the first rub with the state’s trade association. What businessman doesn’t complain about the fees charged for licenses? Those complaints are invariably directed to the trade association, which in turn applies pressure on the board. 

 

But the fact something is broken with regard to preneed is not lost on either the Board or Maryland’s funeral director association. The association position for scrapping the CPA certification in favor of a protection fund probably signals the industry’s acknowledgment that this oversight approach is ineffective and a waste of resources. I have experienced the same frustration working with CPAs and auditors who held themselves as having experience with the death care industry. If each funeral home has to find a CPA to certify compliance with a state law like Maryland’s, HB 1090 may well represent a better application of the funeral home’s funds. However, the real problem with Maryland preneed is its preneed law and the lack of effective oversight. 

 

The dynamics of preneed reform are complicated, but there certain generalities that apply from state to state. No matter how bad your state law is, no one wants to open the law for the donnybrook that is sure to follow if all bars are removed. It doesn’t matter if the trusting is 100% or 80%. If you work in a 100% state, there will be a strident element that argues a lower percentage will open the floodgate to the unsavory characters of preneed (and the criticism of FCA). If you work in state such as Missouri, there is the position that opening the preneed law will invite restrictions that cut into the revenue streams that funeral homes have become dependent upon. However, these arguments are beginning to pale in the face of growing frauds and abuse. Most funeral directors understand that oversight is needed, but the challenge is how to achieve it efficiently on the limited resources available. Shifting the responsibility, as Indiana’s legislature is considering, to the fiduciary will not work. 

 

With regard to Maryland’s preneed law, I would offer the following recommendations:

 

1. Require an independent, corporate trustee that can invest pursuant to the Prudent Investor Rule. Scrap the concept of letting a funeral home serve as a trustee (or escrow agent).   (And what is a trust that is insured by the FDIC?)
2. Require a combination of flat fees and per preneed contract fees that are divided between a protection fund and the Board’s costs to monitor annual reports and to take enforcement actions. The per contract fees should be assessed equally from the funeral home and the consumer (perhaps $10 each). 
3. Each preneed seller should be required to file an annual report that sets out new contract information, deposits to trust, distributions from trust, the trust’s market value and the trust liability. 
4. Each preneed seller should be subject to a tri-annual inspection that may last between 1 to 3 days. The inspection reviews the funeral home’s records, accounting controls, a sampling of transactions (deposits, distributions) and the annual reports filed with the Board. The inspection should be conducted by a CPA firm pursuant to agreed upon procedures developed by the Board, with the cost of the inspection being assessed against the funeral home. The better the funeral home’s records and procedures, the more likely the inspection can be completed in a day (and the lower the fee). With a fixed number of inspections per year, the Board should be able to negotiate a fee that is substantially less than the CPA certification required by the current law.
5. Inspections that reflect violations or deficiencies can be the basis for full audits (which are assessed against the funeral home).
6. Final inspection reports should be a matter of public record so that consumers can investigate funeral homes before making a preneed contract purchase.
7. Preneed sellers should have to obtain trustee certifications of new contract deposits, and then provide documentation to the new contract holders of the deposit of their funds to trust.
8. Preneed trustees should provide annual summary statements (transactions and asset listings) directly to the Board. 
9. Trust transfers should be documented to the Board.

Protection funds have merit, and should not be discounted as a ploy. However, preneed oversight is becoming a national issue. Documentation and disclosure will be fundamental to providing an adequate audit trail for regulators. Maryland funeral directors may have legitimate complaints for dropping their current oversight, but they should not opt for a protection fund in lieu of oversight. 

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The families of those buried at Grandview Memorial Gardens are angry.  First they are advised that the trusts meant to fund future burials and the care for those graves are not properly funded. Next, they learn that some of the cemetery’s gardens have a problem with grave spaces flooding with water. When Indiana regulators and prosecutors reported there was nothing they could do to correct the situation, plaintiff attorneys filed a class action suit naming several entities as defendants, including three banks and the consolidator that sold the cemetery in 2001. The Indiana legislature has also reacted to the situation with a bill intended to eliminate the ability of the death care industry to use a custodial arrangement for these funds, and to place a greater burden on fiduciaries to police fund distributions. 

Are Grandview’s problems the fault of the three banks named as defendants in the lawsuit?  Of course not.  Should the preneed fiduciary be required to police distributions to the extent required to determine if the vault delivered is a 'sealer' or not?  Of course not.  The Grandview situation may be more indicative of the problems facing the death care industry than the irregularities facing the Illinois Funeral Directors master trust.  There are several factors that have contributed to the Grandview situation. Consequently, there are no simple answers, and shifting the blame/responsibility to the financial institutions that serve the death care industry is short sighted and counterproductive. 

Indiana’s death care laws are a hodge-podge of sections spread among different chapters, with different effective dates. If funeral directors and cemeterians cannot accurately cite the legal requirements for their trust funds, should legislators pass the responsibilities over to the financial institutions? 

It doesn’t take much speculation to guess why Indiana’s regulators have not taken any actions. More than likely, the Grandview accounts complied with the Indiana laws (albeit they were likely set up as custodial accounts). This won’t stop the class action attorneys from pursuing the deeper pockets of the banks and Carriage. 

If the death care industry should decide to take steps to improve the image of preneed and perpetual care, death care fiduciaries have to be afforded the resources and procedures required to provide meaningful oversight to account distributions. Fiduciaries are completely dependent upon the death care company for the documentation required for substantiating distributions. Many fiduciaries rely upon certifications from the death care company that a contract has been performed pursuant to its terms. But such procedures cannot ensure that a family receives a ‘sealer’ vault, if that is what the preneed contract called for.  HB 1026 will not solve Indiana’s preneed woes. The problem is deeper than the water that filled Grandview’s vaults. 

The approach taken by Grandview’s class action attorneys reminds me of the search for the infamous Keyser Söze.  As if they were reading from the script for The Usual Suspects, the attorneys advise they think they have it figured out but that legal process will have to grind out justice slowly.  For the sake of the Grandview families, we hope there will be a different ending than what happened in the movie. In real life, there is no Keyser Söze to whom all blame can be attributed.  Instead there are only some bit players who followed the twisting trail of Indiana law, and the only characters likely to profit from this drama are the attorneys. 

To help the Grandview families, the first course of action needs to be the repair of the cemetery’s drainage system. If the cemetery’s perpetual care fund was depleted through improper distributions, determine who did so. There has been little press coverage about the prior owner’s response to the perpetual care issues. Did Madison Funeral Services understand the requirements of cemetery maintenance when it purchased Grandview from Carriage in 2001?   Did the more stringent perpetual care law govern Grandview’s fund?   How much of a perpetual care fund did Madison receive from Carriage? 

With regard to whether the Grandview families were defrauded with inferior vaults, what did the preneed contracts provide? If one reads between the lines, the Jefferson County Prosecutors are indicating there is no basis for a fraud prosecution. The statute of limitations excuse sound like, ah, an excuse.  Doesn’t the statute of limitations start from the point of the discovery of the fraud? If consumers were promised a ‘sealer’ vault, and an investigation does not prove the fraud for 8 years, has the statute of limitations just been triggered? The danger for the Grandview families is that the contracts don’t call for a ‘sealer’ vault. Someone may have planted the ‘sealer’ seed in their minds, and we should hope it wasn’t someone looking to profit from the families’ emotional distress.

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The Iowa had not one, but two personal preference bills pending before its Legislature for the 2007/08 term: SF 473 and HF 2088.   The Senate version, SF 473, was backed by Iowa’s attorneys, and the House version, HF 2088, was backed by the Iowa Funeral Directors Association. 

What caught my attention about these bills was the IFDA statement published by the Des Moines Register on February 22nd. The death care industry would have been better served if the IFDA had given more thought to their position against SF 473. The IFDA statement started with the following:

I must clarify your Feb. 14 article, "Bill Gives Deceased Control of Remains." Iowa funeral directors have always believed funerals are about loved ones gathering to commemorate the deceased person's memory. Funeral ceremonies are not about the dead forcing their intentions on loved ones.

There’s no argument that funerals have been for the living. It is a ritual that is meant to help survivors to take the next step on life without the individual who just died. But how can the IFDA reconcile the highlighted statement with the preneed transaction that most funeral homes endorse.  Yet, I believe the IFDA correctly identified the issue that should be addressed before a preneed contract is ever signed:

If someone has specific requests for his or her funeral, those must be communicated to their loved ones. Funeral directors bring families together to decide how to remember the dead. SF 473, backed by the Iowa State Bar Association, allows a "final disposition directive," which forces everyone to listen to a document, and not to the emotional needs of survivors.

The [attorneys bar] association's proposal could conflict with other legal instruments. What if the decedent's will, pre-need funeral contract and final disposition all request burial, but in different cemeteries? What if the final disposition designates some distant cousin to be in charge?

The IFDA is asking the right questions, but failing to look in the mirror to understand how the death care industry is contributing to the problem. 

First of all, each individual should have the right to control the disposition of his or her body. Period. But in contrast to our ‘inalienable’ rights, we are powerless to defend the right to control our own disposition.   After we cash in our chips (pardon the pun), we are completely dependent on someone else respecting our ‘instructions’. Most individuals seem to have a strong personal preference for what should be done with their body. In a sense, there seems to be a certain selfish aspect to one’s last act or wish being one of “this is what I want”.   Unfortunately, many preneed programs seem to cater to this self-indulgence. 

What may be galling some funeral directors is that the written document, whether it is disposition directive or a preneed contract for cremation, may not be in the best interests of the surviving family members.

First preneed, and now enforceable disposition directives, are underscoring that the role of the funeral ritual needs to be for both the deceased and the living. But to accomplish such a goal, the individual must overcome the reluctance (or denial) that precludes the discussion of mortality with family or friends. 

Preneed introduced our older generation to the issue of their own mortality, but hasn’t provided them the resources to share fears and values with the next generation.  And now the death care industry is being forced to redefine the preneed transaction from being about “me”, to being about “us”. To incorporate family members into the process, key decisions about the funeral must be deferred. Individuals will continue to want to address the financial burdens of the funeral, but the industry needs to become receptive to allowing the family the freedom to reach a common decision about what ritual is best for everyone. 

Bill Tammeus, a Kansas City Star columnist on issues of spirituality, addressed these issues from a theologian’s perspective in a September 2, 2006, column titled “The Cremains of the Day”.  

So which Iowa bill should be favored? In this situation, the attorney’s version provides a lower hurdle for the individual wishing to establish an enforceable disposition directive, and therefore I would endorse it over the IFDA bill. SF 473 should better protect the interests of the elderly and the gay community. 

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One of the many issues facing regulators in the Clayton Smart debacle was the surrender of thousands of Forethought life insurance policies by a Forest Hill preneed trustee. New light will probably be shed on this issue with revelations that Robert Nelms and Clayton Smart may each have been using the same financial management company: Security Financial Management Company. One needs to consider whether an investment advisor looked at the insurance being held by the preneed trust and boasted ‘we can do better’.

Preneed funeral contracts are generally funded by either insurance or trusts.  Each has its advantages and disadvantages.  However, the respective advantages are generally lost when the preneed trust holds insurance products as investments.  (I will exclude cemetery preneed trusts from this discussion because cemetery merchandise is often delivered prior to the purchaser's death, thus making life insurance impractical.)

 Insurance gets the nod as the preferable funding vehicle for portability, tax consequence (to the purchaser) and consumer savings (if you're under the age of 60-something and in relatively good health).  Trust funding gets the nod for universal availability, long-term performance (if the trust has sufficient assets to permit diversified investments) and refund rights (okay, okay, put the state law variations aside for a minute).  However, each type of funding has its unique 'costs', and combining them may cost the funeral home and consumer in the long run. 

Trustees were first induced to accept insurance products in the late 1980s when annuities were purchased for trusts that could not comply with the retroactive application of Revenue Ruling 87-127.   Many of these trusts lacked the information required to report income to the purchasers.  As a grantor trust, preneed trusts could hold an annuity and have the contract's increase be deferred for tax purposes until the contract's maturity.    

Once the camel's nose was in the tent, insurance companies began to market life insurance and annuities to death care companies as solutions to lagging trust performance.  Corporate trustees often consign smaller preneed trusts to fixed income investments in a conservative approach to avoid market fluctuations. In this era of relatively low interest rates, insurance products can offer a better return than conservative bonds and government securities. And, there is the temptation of a commission on the conversion of the trust's assets to insurance. 

However, insurance products represent problems to the corporate trustee.  As demonstrated by Clayton Smart's short-sighted actions, cashing in life insurance before the purchaser's death will have a significant adverse impact on the trust's value.  Cash surrender values on 70-something year old insureds are typically low.   And if the trustee does hold the policy to maturity, how are the insurance proceeds to be taxed?  Annuities simply defer the income aspect of the contract until maturity.  Life insurance proceeds are not taxable to an individual beneficiary, but are those proceeds taxable to the trust?   More than likely, the answer is yes.  The proceeds must generally flow through the trust, thus adding time and cost to the administration. 

Funeral directors need to consider that rolling a preneed trust into insurance is probably a one-way transaction. Once it has been done, it will be a matter of a few years before an investment advisor recommends that its time to cash those policies in. Two wrongs do not make a right.   In many states, it would be difficult to justify a rollover in the first place.  Funeral directors will only compound any error made if they change their minds and cash the policies in. 

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The Funeral Monitor and the Funeral Service Insider write to different segments of the death care industry, and rarely report on the same topics.  So when each makes National Prearrangement Services their lead story in late January, readers should take notice.

NPS is a company that has always pushed the envelope.  With preneed laws as ambiguous as they are, there is plenty of room for wiggle when it comes to compliance.  In the past, competitors would point a finger in NPS' direction and complain about a level playing field.   Funeral directors generally stayed out of that fray because they were being paid by NPS.  With the issues being reported by trade journals about NPS, funeral directors need to reevaluate their agreements with the third party seller. 

To NPS' credit, they can bring economies of scale to bear on a casket company that small funeral homes can not.  But what about the funeral home's existing agreements with casket vendors?   What happens if NPS' relationship with the Chinese sours in five years?   Does the NPS proposal put funeral homes at risk in satisfying the terms of the preneed contracts?  In one perspective, NPS has put the funeral director and the preneed purchaser in the same boat, that being dependent on NPS and its casket vendor being able to perform at some point in the future.

Funeral directors should heed the advice that Josh Slocum gave consumers after the AARP published its notorious RIP Off article:  take your contract to an attorney for advice about your rights. 

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Death Care trade publications such as the Funeral Service Insider and the FuneralWire advocate that funeral homes revisit the non-guaranteed preneed contract.  I agree that funeral homes should reconsider the non-guaranteed preneed contract, but for reasons different from those expressed by other authors.

The non-guaranteed preneed contract affords flexibility and portability to the individual who wants to do more than preplan, but is not prepared to make all of the decisions that go into planning the final disposition.  The guaranteed preneed contract often ties the hands of the consumer's survivors and the funeral home.   While many families take satisfaction knowing the prearranged funeral, some survivors feel they have been deprived the final opportunity of taking care of a loved one.    

Rather than espouse one form of preneed over another, funeral homes need to provide a viable non-guaranteed arrangement that can be selected in lieu of a guaranteed contract. There is a place for both types of contracts.  However, there are a number of hurdles to the non-guaranteed preneed transaction.  In this post, I will identify those issues briefly, and provide expanded discussions in subsequent posts.

• Most state preneed laws have been written with the guaranteed contract in mind.
• Marketing - proactive vs passive
• Efficient trust management
• Finding a sponsor

 

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The Clayton Smart debacle has been, and will continue to be, the subject of articles calling for preneed reform. A recent AARP article titled R.I.P. Off  will be one of the more controversial (leading to frequent citations by consumer advocates).   While the article is biased and should be rebuked by the death care industry for its various flaws, the industry should examine the Smart affair and the public's reaction to Mr. Yeoman's issues (including the comments posted to the AARP website). 

Mr. Smart exploited the Tennessee laws to divert millions of dollars of trust assets.  While Forest Hill's new owners should be applauded for taking steps to minimize the loss to consumers, the industry should not ignore the magnitude of the fraud committed.  Over the next few months, I plan to revisit the Smart affair and the issues it spawns.  But for this post, consider the missing fiduciary.

In its April 2007 edition, the American Funeral Director reported in detail about Mr. Smart, including his appointment of a small Indiana institution as Forest Hill’s preneed trustee and the revision of the governing trust instrument.   While another of Forest Hill’s trustees discharged its duties to consumers by refusing Mr. Smart’s distribution instructions, the Indiana institution followed Smart's instructions to terminate life insurance policies that would result in millions of dollars of loss to the trust.  Too frequently, funeral directors exhibit the similar business ethics by shopping for a trustee that will do what it is told.   

Many of our country’s larger banks now refuse to accept death care trusts either because the laws are ambiguous or because of the industry’s reputation.   Death care companies need to develop procedures and controls to ensure compliance, accountability and transparency.  Restoring the confidence of  financial institutions and consumers will take time.   

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