Dark Clouds and Preneed
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.
