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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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