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

For the past few years, some Kansas cemeteries have been getting nasty grams from their regulator about their care fund trustee’s treatment capital gains taxes. Kansas, like most states, requires a portion of each grave space sale (interment right) to be contributed to a fund or trust for the future care of the cemetery. Kansas law calls that fund a permanent maintenance fund. Missouri law calls it an endowed care trust. In some states it is defined as a perpetual care trust.

Despite what the fund is called, these state laws universally seek to provide the cemetery a source of income to pay for the upkeep of graves (while keeping the contributions in tact). That latter objective, protecting the contributions, brings cemeteries and regulators into conflict when the fund realizes capital gains and losses. The Kansas cemetery regulator has been taking the conflict a step further by interpreting the law to preclude the trustee from paying taxes or fees out of capital gains.

The Kansas regulators (like many of their peers) perceive a ‘looming’ problem with cemeteries: abandonment and the eventual transfer to the municipality or county. Cemeteries are dependent upon the cash flow that comes from space sales (and the accompanying interment fees and marker sales). When a cemetery runs out of spaces, grave maintenance will be completely dependent upon income from the care fund. To minimize the financial burden placed on the county, the Kansas regulator has adopted a very strict interpretation of the law for the purpose of preserving the care fund for the day the cemetery transfers to the government. This interpretation not only precludes the fund from distribution capital gains earnings, but also the trustee’s payment of taxes and fees from the earnings. The regulator reasons that capital gains must be allocated to principal, and the law forbids all distribution of principal.

This puts the cemetery into a bind. The staple of care fund investments, the fixed income security, has been bearing returns of less than 2% for years. When trust expenses are netted from those returns, there is little left to distribute to the cemetery. Necessity has dictated that these funds begin investing in equities. But, the Kansas philosophy would penalize the cemetery. Not only is the cemetery prohibited from using the equity earnings, the cemetery must also pay the taxes incurred on those earnings (reducing what is received from the care fund). The only ‘winner’ is the county. Or is it? If the eventual abandonment takes years, and the cemetery has been deprived income for upkeep and repairs, isn’t the county getting the property in worse shape?
 

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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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A few months ago, a stock analyst issued a critique warning against investment in the industry’s public companies. A few weeks later, the critique got a second wind when chat pages and social media forums picked up on the critique’s conclusion, and circulated the article as proof that certain trends will ‘haunt’ all funeral homes and cemeteries for years to come. Several weeks later, the critique’s attempt to assess or explain the industry’s key issues continues to haunt me. If a professional who makes his living from investment assessments has difficulty grasping and explaining the intricacies of the death care industry, consider the difficulties our regulators and legislators may have understanding the business.

The critique identified “the” three issues impacting the industry’s revenues and profitability: cremation, preneed and longer life expectancies. This post will focus on cremation.

The analyst opens with the statement that ‘several unfavorable secular trends’ are hampering long-term growth and profitability in the death care industry. But, the critique concludes with sticking the “unfavorable secular trend” label solely on cremation. There is no doubt that cremation is turning the industry on its head, but is the “secular trend” label important? It is when you view the history of the business, and need to convey the depth of the cremation issue, and that it will continue to grow.

The American way of death was shaped by the Christian funeral and burial. Theology professor Thomas Long has written several insightful books and articles regarding the Christian funeral and the role of the body. Another excellent work is Paul Irion’s “The Funeral: Vestige or Value?” The growth of death care business can be traced to the fact funeral homes profited by establishing a good relationship with the local church. That fundamental relationship served the funeral home well for several generations. But as our society became more pluralistic and secular, the acceptance of cremation grew.

For theologians, cremation represents a challenge to long standing beliefs about the funeral ritual. But, the emerging message to clergy is one of education and adaptation. As a follow up to his seminal work on the funeral ritual, Paul Irion wrote a book simply titled “Cremation”. This blog has previously discussed this issue, and one form of adaptation by churches: the columbarium.

For the funeral director, a church’s shift to embrace cremation sends a mixed message. The families from these churches view the funeral as having value as a ritual, but a ritual that does not require the purchase of a casket. If the funeral home does not own a crematory, the director will have to compliment the church’s pastoral care, or risk losing the church’s business altogether.

Operators must also market to a public that has become more secular, and view the funeral home as providing a utilitarian service. As the analyst alluded to, once the body is disposed of, all other services are ‘auxiliary’ in nature. The secular public is more likely to purchase a cremation, and forego any type of memorial service.

While cremation has taken away casket sales and cut into the purchase of services, is the critique accurate in its warnings about the death care industry? Keep in mind that the analyst was assessing the industry for profitability and growth, and that growth is difficult for a mature industry to achieve. The death care business has all the characteristics of a mature industry: limited or declining markets, intense competition, and evolving consumer demands. Individual companies may be able to achieve growth, but the industry as a whole may not until the Baby Boomer generation ages another 10 years.

Some mature industries do wither and eventually die away. But in contrast to industries that produce a product with a definitive life cycle, death care is based on a service that will always be needed. Funeral homes may have been guilty of having allocated too much of their profit to the sale of a casket and too little to their services. But, they have the ability to adapt their pricing strategies. For the small operator who cannot afford a crematory, alkaline hydrolysis may provide a less expensive investment. And, there is the green burial alternative to explore.

Next: Dark Clouds and Preneed
 

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Conventions and seminars provide trade associations and trade journals important sources of revenue. Accordingly, the death care industry has plenty of ‘retreat opportunities’ to choose from. However, there will be a death care convention held in Montgomery Alabama this weekend that will be off limits to funeral directors, cemeterians and their legions of industry vendors.

Death care regulators have their own association, and its convention agenda includes several roundtable discussions. These roundtables provide a forum for administrators, agency directors, investigators, examiners, auditors, attorneys, compliance officers, and staff personnel. Regulators won’t freely admit it, but many do not understand the business practices of this industry and the convention may be one of the few opportunities they have to share information and ideas. But, ID will be required for admission because industry representatives are not allowed. (A sad reflection on the fact that regulators don’t feel they can quite trust some industry operators.) 

The exclusion of the industry from regulatory meetings should be a cause for anxiety to operators. With the preneed scandals that have occurred during the past few years, these same regulators are being forced to assume a greater role in preneed oversight.  In the next year or so, our Midwestern regulators will actually be reviewing those annual reports and then visiting to ask questions. If the regulator has some misconceptions about business practices, that tends to influence their interpretation of applicable law, which affects the direction of their inquiries. If misconceptions must be addressed operator by operator, the correction process will be slow and painful.  

Keeping the regulator ‘in the dark’ has been the historic strategy. Preneed oversight is on the rise, and it’s time to begin engaging your regulators and earning their trust.

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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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Veterans Day invariably results in a few newspaper articles similar to the one written about the Pittston City Cemetery. Out of respect for veterans’ graves, this small Pennsylvania town is seeking volunteers to provide care to its cemetery. Budget cuts and personnel cuts have left Pittston without the resources to provide maintenance to the cemetery.

The Pittston cemetery plight provides a context to one funeral director’s assertion that municipal cemeteries represent a ‘true value’ to consumers. The funeral director fails to grasp that the grave at a municipal cemetery is priced artificially low. Most municipal cemeteries are exempt from contributing to endowed care funds intended to provide care to the graves. Instead, taxpayers must subsidize the cemetery’s care. In lean times, the cemetery must go without care.

But for the veterans, would Pittston be seeking volunteers to cut the weeds and clean up the cemetery? Even in death, these veterans continue to serve their community.

Before purchasing a grave space, consumers should ask the cemetery how its maintenance will be funded in future years. If the cemetery maintains a care fund, determine whether it complies with state laws, and request information about the fund’s trustee.
 

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The Federal Reserve’s December 17th decision to cut its interest rate to less than a quarter of a percent is meant to encourage investors back into the stock market. But for many cemeteries, the prospect of depressed interest rates will have dire consequences to endowed/perpetual care trusts that are subject to state laws which limit or restrict equity investments.

State laws have historically imposed conservative investment standards upon endowed care funds to ensure preservation of the trust corpus. However, the bull markets experienced during the past decade often came at the expense of bond returns and other fixed income investments. With stagnant returns, cemeteries in states such as Michigan and Missouri have been seeking law changes to allow endowed care trusts to diversify for growth and larger distributions.

In 2006, a straightforward approach was introduced in the Michigan legislature. HB 6254 would have allowed an endowed care trust to distribute 50% of its accumulated net capital gains to the cemetery operator. However, that bill got lost in the turmoil of the Clayton Smart fraud. Instead, Michigan is now on the road to a more complex approach to diversification that incorporates the Prudent Investor Rule and oversight governed by rules and regulations to be promulgated by the Cemetery Commissioner.

Some of Missouri’s cemeteries introduced the unitrust concept to legislative negotiations held in 2007, and then again in Chapter 214 hearings held this past summer. That proposal would allow the cemetery operator to make an election to require the trust to make an annual fixed distribution of between 3 to 5% of the trust’s value. Missouri’s cemetery law (Chapter 214) lacks a clear definition of “income”, and regulators have taken contradictory positions over the years about whether capital gains may be treated as income to be distributed to the cemetery operator. In an attempt to clarify this ambiguity, the cemeteries turned to Missouri’s Uniform Trust Code and RSMo Section 469.411 to provide a clear standard for income, to promote diversification and to provide cemetery operators greater distributions. But in doing so, the proponents have ignored certain realities, and the controversies that surround the unitrust concept.

Many endowed care trusts are too small to effectively diversify for a fixed distribution of 5%, and proponents have fought alternatives that would grant the trustee authority to reduce distributions below 3%. The proposal would also restrict a trustee’s authority to make income and principal adjustments, a crucial element of the Missouri law.

In view of the current financial environment, cemeteries need the authority to diversify endowed/perpetual care funds. But, a balance needs to be struck between fostering growth in the trust and meeting the cemetery operator’s income needs for maintenance and care. Finding that balance should not be left to the unitrust concept, and faith in the stock market.

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Even when the need for reform is apparent to all, the legislative process can take years. With the Michigan Senate having approved a House substitute, that state’s cemeteries are a step closer to reform that could have avoided Clayton Smart’s pillaging of $70 million dollars of endowed care funds.

The Michigan Legislature’s website provides the history of SB 0674, from its introduction in August 2007, to the Senate’s December 19th vote to adopt the House substitute. Including the Attorney General’s investigation, the Michigan reform process has taken over two years. As with all reform efforts, some were not happy with the delays encountered in the Legislature’s efforts. Getting it right is not as easy as it would seem.

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