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

For many Illinois funeral homes, April 15th served as a bitter reminder of Merrill Lynch and the financial losses suffered by the IFDA master trust. The final Merrill Lynch settlements (approximately $41 million) were received in 2012, and taxes had to be paid on those funds this past tax day. Funeral directors have questioned how those settlement payments could be taxed as income after the losses suffered when Merrill Lynch (as trustee) terminated the key man policies sold to the trust by a Merrill Lynch investment broker. After all, the aggregate settlement payments ($59 million) did not come close to covering the write downs taken by the trust ($76 million). But, Merrill Lynch took the position that a write down in a funeral home’s trust value for policy surrenders did not represent an investment loss. To compound the situation, Merrill Lynch filed a final Form 1041qft for each funeral home that transferred out of the master trust and treated the trust as terminated.

The question is whether Merrill Lynch could have characterized the value write downs so as to afford the funeral homes a capital loss carry over that could be applied to the settlement payments and future income. If one assumes the lowest Form 1041qft tax rate of 15%, Merrill Lynch could have saved the IFDA master trust participants income taxes of approximately $11.5 million.

With Merrill Lynch now out of the IFDA picture, funeral homes may want to turn to the IFDA’s new trustee for assistance. If the write downs can be properly characterized as losses that can be used as capital loss carryovers, it may be worthwhile to have those ‘final’ 1041QFT returns amended. As fiduciary of the Wisconsin Master Trust, the IFDA trustee may have already contemplated this issue.
 

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More than one funeral director has expressed the opinion that the State Board should never have been given rule making authority. We'll never know, but if the State Board had rulemaking authority 22 years ago, it could have implemented rules to help enforce NPS' 1990 settlement agreement, and thereby avoided that company's collapse. But equally important, rule making authority provides the State Board the means to clarify the ambiguities and gaps that exist in Senate Bill. No 1. This is as much to assist the preneed seller who has a business practice that does not fall neatly within the law as it does the State Board attempting to address how that practice should be regulated.

But, Missouri's first attempt to pass a 'conventional' preneed regulation has been a trying exercise for the State Board, its staff and the industry, with mutual frustrations getting the better of everyone. All concerned may have been spoiled by the level of cooperation exhibited when emergency regulations were needed to keep Missouri's preneed industry operating. Had it not been for those emergency regulations, Missouri's preneed industry would have come to a screeching halt for months.

Following the passage of the emergency rules, the State Board staff recommended that the industry's other SB1 complaints be tabled to provide the financial examination process the time required for Division personnel to 'get their arms around the issues". That made perfect sense to this author, that is until the insurance assignment became the focal point for the Board's first regulation.

The political realities are that the State of Missouri needs revenues, and the excess insurance proceeds paid to funeral homes should be paid to the State pursuant to RSMo 208.010.7(4) before refunded to the families of assistance recipients. If funeral homes use the spend down provisions to their benefit when meeting with families, then they should also have a duty to comply with Chapter 208. But, the problem has been that families were allowed to exclude insurance policies for asset testing without a preneed contract, and the drafters of SB1 were focused on NPS and the sale of preneed contracts.

SB1 has flaws, and the Division once acknowledged that corrective legislation would eventually be needed. Our question is whether the Board's first regulation is indication that the State now has a double standard when it comes to preneed regulations and the need for corrective legislation: a restrictive interpretation of SB1 for the industry and a liberal interpretation for itself?

Like SB1, the Board's first regulation proposal was forced by the State, and has its own flaws. The proposal is too broad in attempting to define all insurance assignments and beneficiary designations as the consideration that triggers SB1. The proposal also extends the preneed contract fee without an explanation of the examination procedures needed for the transaction. Then to buttress the position that the regulation binds all outstanding insurance assignments, the State relies upon a confidential legal memorandum as having put the industry on notice. If the industry does not find the State's rationale credible, many funeral homes may refuse to comply. We find it frustrating that the State could accomplish most of what it wants without sacrificing credibility. That credibility will be important to getting funeral homes to embrace the future changes required for compliance with SB1. It remains to be seen whether the State will be flexible with the industry in achieving their mutual goals.

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Three years ago we asked that question with regard to the power struggle occurring between the Missouri State Board of Embalmers and Funeral Directors and the Missouri Division of Professional Registration staff. That post was influenced by our experiences with preneed regulators from other states, who range from elected politicians to the revolving door bureaucrat. I would always prefer the experience and stability of a Dennis Britson or a Mack Smith, but they honed their skills over decades, and Missouri is under a bit of pressure to get reform rolling. With the Missouri Legislature having vested preneed supervision with the industry, we saw hope that Missouri could establish a unique structure where the experience of the industry would mesh with a staff with long term commitments. But silly me; the regulations drafted in response to a December vote on insurance assignments provide the answer to “Who is the Boss?” It is the Governor.

I must confess that my mind drifts at times when I attend the State Board meetings. Okay, I also check emails from time to time when the Executive Director gives her reports. But, the regulation proposals leave me wondering whether I was in the wrong room last December. But, Mr. Otto did whisper to me from time to time during the meeting I thought was the State Board’s. Maybe we were at a MFDEA meeting? Then again, I recall a unanimous vote that defined the insurance assignment as a preneed contract that was to be exempt from the $36 fee.

My warning from the “Who is the Boss” post in 2010 was this:

Death care operators are often frustrated when regulators take actions that demonstrate a lack of understanding of the business (or worse yet, a misunderstanding of applicable laws). The risk to both the death care operator and consumer is when the elected preneed regulator allows politics to influence the reform process. Elected regulators may pose the greatest challenge to developing effective preneed supervision, and then maintaining that system.

It is obvious the Governor doesn’t read this blog. Since 2010, an elected politician has made insurance assignments our preneed reform priority. I get it. The excess insurance proceeds could help offset the benefits paid to nursing homes, and Chapter 208 requires a Chapter 436 preneed contract. The State doesn’t want to revisit Chapter 436. It would be easier to manipulate the language of SB1 to get the desired result. (It’s not like the industry doesn’t do it too.) It took the State Board 18 months to offer a compromise, and one that was a win-win for the state and the industry. But, you are overplaying this hand by demanding the $36 per contract fee.

For the past two years, the industry and Board members have asked what the Division really needs in terms of fees to conduct exams. The answers have been evasive at best, but I could defend that response because the examination procedures are work in progress. But, your regulation proposals indicate that “The costs for the Board to administer preneed contracts is the same per contract, regardless of the value of the preneed contract.” If that is the case, then what is the cost per contract to perform a preneed examination? I find the Division’s budget for the State Board confusing, but the numbers attached to the agenda are significant. Is the Division receiving more that it needs, and if so, where do those funds go?

Up to this point, the examination procedures have focused on recordkeeping and confirming that consumer funds were deposited to banks and insurance companies. At some later date those procedures will need to look at how those funds are administered and paid out to funeral homes. But, until then, why is the $36 fee required on a transaction where the funeral director does not receive funds until after a death has occurred?

Three years ago I defended the slow pace of the Division, and advised the industry that reform required a shared responsibility between the Division and the State Board.  Accordingly, please respect the Legislature and let the State Board perform its role for reform under SB1.
 

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Recent document disclosures are reflecting that several factors contributed to the WFDA’s master trust deficiency (and the appointment of a receiver). Certain of those factors relate to the fees paid to fund managers and the association’s sponsorship charges. Those factors are relevant to other association master trusts, and we will explore them in subsequent posts. However, the ‘straw’ that broke this camel’s back came straight from the National Prearranged Services’ playbook.

The Wisconsin State Journal reported that it was the formation of a life insurance company by the WFDA’s Wisconsin Funeral Trust that prompted a regulatory audit by the Office of the Commissioner of Insurance. In 2009, the WFDA used the master trust to set up an insurance company to provide its members a preneed funding alternative to the trust. Wisconsin law requires 100% of the consumer payments to be deposited to trust. In contrast, insurance funding provides funeral homes commissions to offset the costs of a preneed program. This same reality led National Prearranged Services to form a life insurance company. NPS needed an insurance program in order to expand into 100% trusting states. To jumpstart that insurance program, NPS tapped its Missouri and Texas preneed trusts.

NPS exploited a provision of the Missouri law that exculpated the trustee from investment oversight when an independent investment advisor was appointed by the seller. Held harmless by state law, NPS trustees may not have looked further than the statements the seller provided. NPS then appointed an investment advisor that directed the trusts into policies issued by the sister insurance company. In a similar fashion, the WFDA amended its master trust agreement in 2009 to remove the trustee’s investment responsibilities and authorities, and to vest investment control in the fund manager of the WFDA’s choice. And to top that move off, the amendment made information about the trust and parties confidential. If the trustee was unhappy with the situation, it could resign, but it could not make “any public communication that may be reasonably considered derogatory or disparaging to the Association, the Trust, the successor Trustee or any party relating to the Trust.”

There are indications the WFDA funeral trust had been struggling for years to keep up with promised return. But, over the course of three years, the WFDA made radical changes that culminated in the formation of the insurance company. Who was the driving force behind those changes? When advice was sought in 2007 to allow the trust to diversify its assets, the legal opinion was directed to the WFDA executive director Scott Peterson, not the corporate fiduciary.
 

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With the backdrop of another major preneed debacle, Missouri turns its attention (yet again) to the assignment of insurance policies to funeral homes.  On September 25th, the State Board of Embalmers and Funeral Directors will consider a regulation proposal addressing insurance assignments.  Is it, or is it not, a preneed contract?   The industry, and the staff, need an answer. 

The proposal establishes a presumption that all insurance assignments give rise to a preneed contract.  I don't have a problem with such a presumption so long as the funeral home is given the opportunity to rebut that presumption.  The regulation does provide a mechanism for rebuttal, but no guidelines are provided as to what would be excluded from the preneed definition.  Instead, the intent of each funeral director must be examined, and to compound matters, the proposal references 'intent' twice.  There is the question of whether the funeral director had intent to use the assignment for "payment in advance" for goods and services.  And, there is also the question of whether the funeral director had intent to form a preneed contract.  (We can reasonably predict the funeral director's answer to the latter inquiry.)

To avoid a circular inquiry in the mind of the funeral director (and an examination backlog), the Board needs to establish a set of facts that would reasonable exclude transactions that do not constitute the sale of an insurance funded preneed contract.  

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The staff for the Missouri State Board of Embalmers and Funeral Directors released the revised preneed renewal reports this week, and those revisions include a few new additional requirements.  Those requirements include a seller providing a ‘no tax due’ letter, proof of corporate status and any ‘doing business as’ filings.  However, the new requirement that will catch most funeral directors by surprise will be the new Section Q: preneed contracts funded by insurance assignments. 

Section Q seeks from the preneed seller information about each insurance assignment taken to fund a preneed contract.  Funeral directors will find the instructions somewhat confusing.  Those instructions advise that a report is to be prepared for each insurance company, but the spreadsheet format incorporated into the report suggests each column could be for a different insurance company.  The seller is also instructed to mark the spreadsheet with 'NA' if the section does not apply.  With the form instructions alluding to preneed contracts “sold” pursuant to Sections 436.400-436525 RSMo., most funeral homes will assume the assignment of an existing insurance policy is not covered by Chapter 436.  The instructions do not address policy beneficiary designations.

The staff scheduled an August 21^st  State Board meeting that includes “renewal update” on the agenda.  With the renewal forms having only been published on August 17^th, the staff hasn’t given the industry adequate time to provide input at the August 21^st meeting.  This should make for an interesting September State Board meeting, and for October chaos for Missouri’s preneed sellers (and those funeral homes dependent upon third party sellers).     

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Who can honestly say they saw this one coming?

 On July 5, 2012, the Missouri State Board of Embalmers and Funeral Directors filed a complaint with the Missouri Administrative Hearing Commission against a Missouri funeral home for alleged violations of Chapter 436, including several transactions that predate Senate Bill No. 1. So, three years after the passage of Senate Bill No. 1, the State Board has initiated its first formal proceeding against a preneed seller.  SB1 armed the State Board with several new tools, including the preneed financial examination.   Pointing to the massive fraud committed by National Prearranged Services, the State’s regulators convinced the Missouri Legislature that such tools were necessary to protect the consumer.  What misconduct did the new financial examination tool uncover that warranted a formal complaint: the funeral home failed to report, and adequately document, insurance assignments and beneficiary designations.

The crux of the State Board‘s argument is stated in Paragraphs 49 and 50 of the Complaint:

49.       A preneed contract is sold when a seller accepts an insurance assignment or is named as owner (prior to August 28, 2009) or beneficiary of a life insurance policy pursuant to an arrangement between the seller and the consumer to ensure payment for the final disposition of the consumer's dead human body and for funeral or burial services, facilities or merchandise upon the death of the consumer.

50.       ******  Funeral sold and entered into preneed contracts with those consumers specified in Exhibit A when ******* Funeral accepted insurance assignment or was named as beneficiary on an insurance policy when the consumer made such assignment or designation with the intent of paying ******* Funeral for the costs of his or her own final disposition.

The State Board’s position (with regard to insurance assignments and beneficiary designations made prior to August 28, 2009) is based on the following:

31. Section 436.005, RSMo (2000), set forth definitions for the Old Law and stated, in relevant portion:

(5) "Preneed contract", any contract or other arrangement which requires the current payment of money or other property in consideration for the final disposition of a dead human body, or for funeral or burial services or facilities, or for funeral merchandise, where such disposition, services, facilities or merchandise are not immediately required, including, but not limited to, an agreement providing for a membership fee or any other fee having as its purpose the furnishing of burial or funeral services or merchandise at a discount, except for contracts of insurance, including payment of proceeds from contracts of insurance, unless the preneed seller or provider is named as the owner or beneficiary in the contract of insurance[.]

What the State Board is asserting is that Chapter 436 has always defined as a preneed contract any insurance assignment or beneficiary designation made in favor of a funeral home prior to the death of the insured.   That will come as news to most of the industry (99.9% or so), and cause some operators to ask what those six Board Members are smoking.  But for those individuals who regularly attend the meetings of the State Board, this position may not necessarily reflect the views of the State Board members.

The Board’s staff began pressing the State Board more than two years ago to provide clarification on when insurance assignments and beneficiary designations constitute a preneed contract.   At that meeting in Festus, Missouri, the staff also reminded the Board and the industry of the funeral director’s duties under Chapter 208 to make inquiries to the Third Party Liability Unit (of the Department of Social Services) before making refunds to families.   The insurance issue resurfaced last fall (with the conclusion of the initial onsite financial examinations).  Since then, the issue has been bounced back and forth like a ping pong ball between the staff and the Board.   The staff has made various proposals, which the Board has rejected. 

As we have previously suggested, this transaction is one which should be documented by a contract.  Some within the industry assert there is no contract.  I disagree.  The policy owner has made the assignment or beneficiary designation with the expectation that the funeral home will apply the proceeds to their funeral.  The funeral director understands that expectation, and often relies on Chapter 208 for recommending the assignment of insurance.  I agree with the staff in that the ‘professional trust and confidence’ contemplated by Section 333.330.2(14) dictates that this transaction be documented by a contract.  The staff would then argue that any contract made by a funeral home that contemplates future performance must be a preneed contract, and ergo, a Chapter 436 contract.  I disagree. 

Chapter 436 was first enacted in 1965, but was re-written in 1982.  The 1982 law provided the industry the first definition of a “preneed contract”, which was the same as that cited by the Complaint, except that it did not include the following: 

except for contracts of insurance, including payment of proceeds from contracts of insurance, unless the preneed seller or provider is named as the owner or beneficiary in the contract of insurance[.]

There was sufficient confusion whether insurance policies were covered by Chapter 436 that the preceding phrase was added by legislation that took effect in 1986.  The 1986 legislation was hotly debated, and the product of various compromises, and the result included a horribly ambiguous definition.  A literal interpretation of the new “preneed contract” definition would find that an insurance contract is not a preneed contract ‘unless the preneed seller or provider is named as the owner or beneficiary in the contract of insurance’.    But when the seller or provider is named as owner or beneficiary, the contract of insurance is a preneed contract.   That bears repeating: the contract of insurance is a preneed contract.  What the heck does that mean?

The old law was poorly drafted, and ambiguous, in many respects.  There always has been confusion over the extent to which Chapter 436 governed insurance funded preneed.   The old law was written with one preneed transaction in mind: the trust funded guaranteed contract.   Joint accounts were addressed as the first afterthought, and then four years later, insurance was added as another afterthought.   For years the Board staff struggled with whether insurance funded contracts had to be deposited to trust.   And now, 30 years after the old law was enacted, the staff (or is it the State Board) wants to begin enforcing those ambiguous provisions?

What motivations does the staff have for pressing the State Board on the insurance assignment issue?   The need for clarity was the initial explanation given.  The next justification given was the need to protect the consumer.   Both of these have merit, but one can’t help but wonder if Chapter 208 may also provide a third motivation. 

It would be political suicide for any candidate to suggest that Missouri needs to raise taxes.  Instead, state agencies look for other ways to generate revenues, whether that be through fees or charges.  Accordingly, someone in Jefferson City may also be looking at the funeral home’s obligations under Chapter 214.  In conjunction with that 2010 meeting in Festus, the staff has incorporated a MO HealthNet page on the State Board website.   That page is meant as notice to the industry that funeral homes have a duty to make inquiries to Department of Social Services before making refunds back to families.   (You funeral directors can now add tax collector to your job description.)  But that duty only applies to Chapter 436 contracts.

The Complaint seems a heavy handed attempt to force the State Board to define the insurance assignments as Chapter 436 contracts.  While there is need for clarity and consumer protection, neither the old law nor SB1 was intended to regulate the assignment of an existing insurance policy.  SB1 is intended to regulate the sale of contracts where performance is deferred to a future date, and the administration of the consumer’s payments.    The staff must twist SB1 provisions to reach the conclusion that all insurance assignments give rise to a preneed contract.   That approach is not much different from the one NPS used with the old law. 

So, what are those State Board members to do?  Here is a proposal for their consideration.

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For obvious reasons, life insurance is the preneed funding choice for many funeral directors. One hundred percent trusting laws give proactive preneed organizations no choice but to use insurance funding. Insurance provides the commissions needed to finance marketing and a sales force, and, maybe as important, relieves the funeral home from preneed accounting and administration. But insurance funding is predicated on the contract being performed at death. In contrast to funeral homes, cemeteries can (and must) deliver preneed sales in advance of death.

First, and foremost, the grave sale is typically ‘delivered’ as soon as the purchase price is paid. The cash flow generated from the grave sale is too crucial to a cemetery to defer until the purchaser’s death. Few (if any) state laws require the trusting of grave payments, and accordingly, grave sale payments flow directly into a cemetery’s operating account.

Marker and monument sales also generate crucial cash flow to the cemetery. Competition from monument dealers (and funeral homes) prompted cemeteries to offer markers through preneed sales. While it has been customary to defer marker deliveries until death, spiraling granite and bronze costs has forced cemeteries to accelerate deliveries of these sales. Applicable state laws generally require the trusting of preneed cemetery sales, and contemplate trust distributions prior to the consumer’s death.

In contrast to the funeral home, cemeteries do not need insurance for the funding of preneed programs. Cemeteries have an advantage in preneed marketing in that the grave sale has no trusting requirement, and states typically impose lower preneed trusting requirements on the cemetery industry. Where cemeteries feel the insurance void is in the administration required for the preneed sale. Small funeral homes often shun insurance funding in favor of the trust option offered by their state association. There are state cemetery associations that offer a master program, but they are the exception. Consequently, most cemeteries will find preneed to be an uphill climb without the assistance of insurance companies or a master association trust.
 

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For some Missouri funeral homes, the ‘disagreement’ over the Section 436.405.1.(8) and insurance assignments has been brought to their doorstep.  In January, the State Board and their staff debated the issue of whether insurance assignments and beneficiary designations made in favor of a funeral home should constitute a preneed contract. The State Board rejected the staff’s interpretation of the fore mentioned section, and now the auditors seem to be pressing that disagreement to the Missouri’s funeral homes by way of the Chapter 436 financial examination.

This blog went on record in opposition to the staff’s regulation proposal as too broad, but there is also a need to go on record for the need for better consumer protection in these transactions.

When an assignment of insurance (or the designation of beneficiary) is made, it is done so in anticipation that the funeral home will apply the death benefits to the insured’s funeral arrangement. But have there been any promises about the prices or the right of the insured’s family to use another funeral home?  Such issues should be set out in an agreement between the funeral home and the insured so that the insured’s family is not left to guess. 

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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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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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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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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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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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The Illinois Division of Insurance made the right call: the IFDA master trust does not have an insurable interest in the lives of the members who participate in the trust.

A preneed trust is intended to fund the liability that arises when the preneed beneficiary dies and a funeral must be provided. Accordingly, it is appropriate for a preneed trust to hold insurance covering the life of the contract beneficiary. At the time of death, the trust will receive insurance proceeds, and if the trust is established correctly, the proceeds are excluded from being taxed pursuant to Internal Revenue Code Section 101(a). The amount distributed by the trust to the funeral home is treated as ordinary income.

While the funeral director may have a financial interest in the performance of the preneed contract, the director’s death does not create a liability for the preneed trust. In the absence of a risk of loss, the policy held by the preneed trust is taxed as though it were an investment contract. Once the fiduciary factors in the tax consequences and the mortality charge, the decision to dump the key man policies makes sense.

Now the accusations turn to why this wasn’t done sooner. Or, why were these policies purchased in the first place. The broker’s excuse dodges the responsibilities he had to perform research, make inquiries and report accurately to the insurance companies.

Where was the IFDA counsel when these insurance purchases were being made?

Perhaps the regulators have exposure as well, but that may depend on what was disclosed by the IFDA (and when).
 

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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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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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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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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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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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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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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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