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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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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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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A few years ago, a past president of the NFDA wrote in The Director that funeral directors should begin blowing the whistle on industry cheaters. This blog raised a concern over whether funeral directors understood applicable preneed laws well enough to become whistleblowers. A recent news article in the Morris Daily Herald contains facts to suggest an industry member decided to become a whistleblower. The results may have gone further than what the whistleblower expected.

The story comes out of Wilmington, Illinois, where preneed regulation is in a period of transition. At the center of the Illinois storm is the IFDA, Merrill Lynch and the Illinois Comptroller’s Office. From statements provided by a Comptroller spokesman, readers can connect the dots to conclude the funeral home under investigation had participated in the IFDA, and may have failed to deposit to trust the funds received on 8 preneed contracts. With the turmoil surrounding the IFDA, many funeral homes were reluctant to continue making trust deposits.

The Comptroller statements also reference a Freedom of Information request and a complaint. The chances are that someone with connections to a funeral home competitor made the FOI request, and filed a complaint. The Comptroller’s office responded with an examination, but then quickly referred the matter to the State Attorney’s office.

With SB1682 being less than a year old, many Illinois funeral directors remain confused about the law’s requirements. If the Wilmington situation proves to involve a funeral home that erroneously made deposits to a custodial arrangement, the new Comptroller may be sending a stern warning to Illinois funeral directors: get right with the law or face the prospect of criminal proceedings. It seems drastic, but it is also consistent with a trend where regulators are turning to local prosecutors. This is also the response of a newly elected Comptroller who may like nothing better than to have preneed oversight transferred to someone else, even if its piecemeal to a State Attorney’s office.
 

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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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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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Rather than defend the legality of its master trust, the IFDA sought to enforce the gentlemen’s agreement that the association perceived it had with the Comptroller. The 2006 exchange of correspondence reported by the State Journal-Register underscores the risks that death care operators take when they structure arrangements that exceed the parameters of applicable law.

When the applicable law is ambiguous, operators may be forced to go outside the four corners of the law. In those situations, the operator should do exactly as the IFDA did: personally work with the regulator. But it becomes incumbent upon the operator to ‘work with’ the regulator when circumstances force changes to the arrangement.

Reading between the lines, the SJR article suggests that as more IFDA funds were put into insurance, the more the IFDA relied upon its ‘declared’ 2% increase as justification for the fees charged the trust. As that domino fell, next went the IFDA’s authority to act as the trust’s fiduciary.

Rather than continue to ‘work with’ the Comptroller’s office, the IFDA sought to enforce their gentlemen’s agreement. Unfortunately for consumers and funeral directors, that agreement was flawed from the start.
 

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NPS' sister corporation, Forever Illinois, used the Illinois self trusting provisions to administer preneed funds.  As with funeral operators, Senate Bill 1682 will force Illinois cemeteries to seek corporate fiduciaries to administer their preneed and endowed care funds. 

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Last week’s exchange between the State Journal-Register and the Illinois Comptroller’s office underscores just how poorly some regulators (and funeral directors) understand the preneed transaction.

The newspaper’s June 24th editorial included the following statement:

The directors allege they didn’t find out about the audit until fall 2007 when the comptroller revoked the IFDA’s license to be the fund’s trustee.

The Comptroller’s office responded two days later with a letter stating they are only responsible for auditing funeral homes and cemeteries that are preneed sellers, and that the IFDA was not a seller. While this position is consistent with that taken by the Comptroller in its September 17, 2007 letter of revocation, it is wrong nonetheless.

State associations serve as a jack-of-all-trades with regard to their master trusts, including administrative agents. But for smaller operators, the association (or its affiliate) typically serves as the preneed seller, discharging compliance and licensing obligations that are too burdensome for the ‘little guy’. With regard to larger members that have a seller's license, contracts between the association and the member determine who is the seller.

One problem with the IFDA situation was that the preneed contracts were so poorly written it may be impossible to tell who the seller is. But, it was the Comptroller that licensed the IFDA as a preneed seller, and it was incumbent upon the Comptroller to have addressed the contract and fiduciary problems before the license was issued.  It is wrong for the Comptroller to now attempt to duck those responsibilities, or to cram a settlement down the throats of funeral directors on any argument that they were the sellers of the IFDA preneed contracts.
 

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It may be a mere coincidence, but the $9.7 million demand made by Comptroller Dan Hynes upon the IFDA is approximately 25% of the $39 million dollar “deficit” that the master trust had accrued by 2006. In applying the letter of the law, the Comptroller has rejected the IFDA approach of crediting individual preneed accounts with a fixed rate of growth. Instead, the Comptroller has taken the position that the 25% administration fee must be based on actual trust income, and the IFDA has failed to adequately demonstrate what the trust has earned.

As more information is released about the master trust, the more it appears that the IFDA structured the master trust to simulate a defined benefit pension plan. By establishing a fixed rate of return acceptable to funeral providers, the IFDA could apply actuarial studies to project the trust’s liability at future dates (and invest accordingly).

A generation ago, the defined benefit plan was the principal method for funding retirement benefits. Today, however, the 401K plan has replaced the defined benefit plan as the retirement vehicle of choice. Defined benefit plans have proven too costly.

If some twenty years ago the IFDA in fact chose to emulate the defined benefit model, that decision was flawed from the start. Defined benefit plans are subject to extensive rules and procedures established by ERISA. Investments, allocations, related party transactions, expenses and taxes are all subject to strict rules and tests. There are no comparable laws and regulations for preneed trusts. Without similar guidelines and supervision, the IFDA appears to have broken most of the ERISA rules.

When funeral directors fault the Comptroller for not having acted sooner to avoid the trust’s decline in value, they are failing to understand that a substantial portion of the amount written down prior to 2008 represents an accounting change from the defined benefit ‘value’ to the trust’s current approximate market value. There was nothing the Comptroller could have done to prevent that ‘deficit’ from being written down.

With regard to the trust’s value decline since 2007, the key man insurance held by the trust poses a thorny problem. The insurance policies have a mortality charge that must be satisfied from a reserve that is probably invested in a volatile mix of fixed income and equity assets. Surrendering the policies requires the trust to address certain tax penalties and policy fees, unless of course, the policies are rescinded or fail to constitute insurance.

Where does this leave the IFDA and the Comptroller’s $9.7 million claim?

Unless the IFDA has assets (including its museum of funeral customs) sufficient to pay the claim, it will have to earn its way out of this hole. As with most state associations, the master trust represents its main source of revenue. Administrative fees charged to members range from 75 basis points for large trusts to 125 basis points for smaller trusts. Besides individual account administration, these fees must also cover fees for the fiduciary, asset management and tax administration.

In a prior press release, the Illinois Secretary of State put the IFDA trust value at $200 million. For a trust this large, account administration could conceivably receive a fee of 35 to 50 basis points. Assuming the IFDA’s costs to provide such services were $250,000, the association could net $750,000 per year. If the IFDA could apply half of that fee to the Comptroller’s claim, the association is still looking at a very long row to hoe.

But the Comptroller has reasons to consider this alternative. If the claim should prove the final straw that breaks the association, the IFDA master trust may have to be broken apart and transferred to new trusts established by the individual members. This is what happened a few years ago with the Minnesota master trust. The difference with the IFDA situation is that hundreds of members are involved instead of dozens. It would be the Comptroller that must supervise hundreds of trusts instead of a single trust.

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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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