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

The financial fallout from the failures of NPS and IFDA regarding compliance with state and federal laws has accelerated the decision of many funeral directors to switch to the non-guaranteed preneed contract. That non-guaranteed contract represents a fundamental change in the relationship that is established between the consumer, the funeral home and the preneed fiduciary.

The trust-funded preneed contract establishes a fiduciary account that has two beneficiaries: the funeral home and the consumer. It is quite common for fiduciaries to administer trusts with beneficiaries with competing interests. With competing beneficiary interests, the fiduciary must look to the trust provisions, and applicable state law, to determine who may exercise discretionary authorities regarding the trust.

State preneed laws are written in response to existing practices, and historically, the guaranteed contract defined preneed practices. When the funeral home sells a guaranteed contract it is the funeral home that assumes the risk of the trust’s investment performance. With that risk, preneed statutes typically vest in the funeral home the authority to establish the trust, to hire and replace the fiduciary, and to participate in decisions such as investments. State preneed laws have generally been vague or silent about administrative and accounting issues, and fiduciaries have turned to the funeral home for instructions regarding accounting and income reporting.

With the non-guaranteed contract, the funeral home has both deferred the sale of the funeral (until death) and transferred the risk of investment performance to the consumer. Appropriately, the consumer may have questions to put to the funeral home, the fiduciary and the preneed regulator:

• Must the fiduciary follow a different investment policy with regard to funds held for guaranteed contracts versus non-guaranteed contracts?
• How is trust asset value allocated to the contracts?
• How is income and expenses allocated among the types of contracts?
• How will income and expenses be reported?

For many funeral homes, the latter issue (the reporting of trust income) drove both investment policies and accounting procedures. No one likes to get a tax statement on a preneed contract, and so many funeral homes went to tax exempt bonds in belief this relieved the trust from reporting income to the consumer. But, the IRS requires tax-exempt income to be reported because it impacts the taxability of social security benefits. If the consumer hasn’t received an accurate statement of income and expenses, his account has exposure for a $50 penalty if the trust isn’t being reported pursuant to a Form 1041QFT. (This accuracy reporting penalty more than likely led the IFDA corporate fiduciary to effect a Section 685 election for all master trust accounts.)
 

For the upcoming wave of non-guaranteed contracts, there are only two permissible methods of reporting income: grantor statements to the consumer or a Section 1041qft. Regardless of which income reporting method is used, the funeral home and fiduciary can not simply park the consumer’s funds in a tax-exempt fund. The preneed trust’s allocation of income and expenses for tax reporting will be similar for both approaches, thus making the trust’s tax return a tool for regulators when evaluating the fiduciary’s administration and accounting.
 

• Email This
• Print
• Comments
• Trackbacks

A recent news report titled “Broken Trust” served to fan the emotions of Illinois residents who purchased a preneed contract from the Illinois Funeral Directors Association. The facts involve a 103 year old lady who purchased the contract 16 years ago, and experienced a 32% drop in the contract’s value in one year. The news report quotes from the funeral home’s website:

“By locking in today’s funeral costs and ensuring that the necessary funds are set aside, you help relieve yourself of unnecessary future worry and your survivors of an unexpected expense.”

The news report then adds: “For the Graces and thousands of other families in Illinois, it did not work that way.”

The news report goes on to add commentary for consumer advocates advising against the purchase of preneed. However, the news report is very misleading and serves to confuse consumers because of an important fact: Mrs. Grace purchased a non-guaranteed contract.

Contrary to what the article suggests, the Grace family did not lock in the 1994 purchase prices of the funeral home’s goods and services. They have every right to be upset about the recent drop in value, but so do hundreds of Illinois funeral homes.

Over the course of 16 years, Mrs. Grace’s preneed contract has realized an increase of 1.66%. Not a great return. The goods and services selected in 1994 to have gone up at a rate of 4.2%.

While a difference of $4,500 may exist between the value of Mrs. Grace’s contract and the current cost of the 1994 goods and services, the Grace family is not obligated to purchase that same funeral.  The family may choose less expensive goods and services.

The Illinois Comptroller has published various consumer guidelines regarding preneed contracts. All have an explanation of the differences of guaranteed and non-guaranteed.

To avoid unnecessary distress, consumers should read available disclosures closely, review the preneed contracts, ask questions of the funeral director, and involve other family members in the process.

For Illinois families who own a non-guaranteed preneed contract with diminished values, if you demonstrate flexibility over the casket selection, most funeral homes will reciprocate with regard to their services.
 

• Email This
• Print
• Comments
• Trackbacks

The question isn’t whether preneed needs to change, but how to change it.

The November 2nd edition of the Funeral Insider highlights a new industry survey by Citrin Cooperman, a highly regarded accounting firm. The newsletter includes a section on preneed, and experts’ take on the survey. Their consensus is that preneed is broken. (Tell us something we didn’t already know!) But for the sake of giving sound bite advice, the experts compromise valid advice by resorting to generalities and false alarms.

The Citrin Cooperman survey is available for $295, a bit too rich for curiosity purposes. The accuracy of any survey is dependent upon sampling an appropriate representation of the population (in this case, the death care industry). What is lost by the FI critique of the guaranteed contract, is that applicable state law is the single greatest determinant of the structure of the preneed transaction.

Most of the country’s laws were written in response to the guaranteed contract, and do not contemplate any other form of preneed. If applicable law does not specifically authorize non-guaranteed preneed, most funeral directors will be reluctant to offer it. The availability of an alternative to the guaranteed contract is state specific, and therefore a survey limited to four states is of limited use to the remaining 92% of the nation.

With regard to the four survey states, it is worth noting that 8% of the respondents stopped offering the guaranteed contract during the past year. But does that mean 67% of the respondents are following the “wrong” strategy because they continue to offer a guarantee? Beyond state law, consumer expectations and/or competition dictate that a funeral home offer preneed, and then what form of preneed to offer. Most funeral homes are forced to respond to an evolving market, and the preneed resources available. It’s a business decision with many unique factors.

As the FI experts recommend, funeral homes need to pay more attention to their preneed program. But preneed isn’t an addictive drug, it is an option that consumers have come to expect. The problem with preneed is how the guarantee has been used to define the consumer’s expectations. But as funeral homes begin to limit their use of the guarantee and realign consumer’s expectations, preneed will become more complicated (and require more of the funeral director’s attention).

Consumers will still want to address the future costs of the funeral. If they are allowed to fund, but not purchase, how is the transaction to be regulated? Contrary to what one FI expert suggests, regulation of preneed has been based on a transaction involving the purchase of goods and services. Accordingly, many preneed sellers deem the payments as theirs upon receipt, even though those payments may be sitting in a trust, a bank account, or an insurance policy. This view of the transaction is supported by a series of position letters issued by the Securities Exchange Commission’ similar to the one issued to an Iowa preneed seller. The SEC wanted no part of regulating preneed.

As the industry moves to non-guaranteed preneed, or even partially guaranteed preneed, there will be a debate over who owns the trust funds, bank account or insurance policy: the consumer or the preneed seller. The answers will be more complicated, requiring more from our laws, regulators and the documents.

Too complicated for sound bite advice.

• Email This
• Print
• Comments
• Trackbacks

The IFDA seems to be everyone’s favorite whipping boy. Even prominent industry leaders are stepping back from the Association in its time of need. The epicenter for the latest news on the IFDA’s troubles has been the Springfield Journal-Register and Bruce Rushton. Mr. Rushton has done a thorough and excellent job of reporting on the IFDA master trust. In support of that reporting, the Journal-Register published an editorial calling for action to protect Illinois consumers. In response, Springfield funeral director Chris Butler wrote to the Journal-Register to present a different perspective of the reporting and editorial. I, for one, agree with Mr. Butler that the Journal-Register is contributing to the confusion and anxieties of consumers who hold a preneed contract.

References to the IFDA master trust as a Ponzi scheme have been abused. It’s a fact that the IFDA made promises to its membership that it has not been able to keep. In a very literal sense, this may seem to fit the Ponzi scheme definition, but the IFDA master trust does not begin to equate to the Bernie Madoff fraud, or even the NPS business model. Certain factors have contributed to a liquidity problem for the master trust. The single greatest factor, the collapse of the financial markets, is completely beyond the IFDA’s control. Rather than sell off assets at a loss, fiduciaries in this situation would prefer to use incoming funds to meet liquidity needs. This is not the classic Ponzi scheme.

As Mr. Butler suggests, it is the Illinois funeral director who will bear most of the financial consequences of the master trust deficits. While there is a legitimate exposure to the consumers holding non-guaranteed contracts, the IFDA must be afforded the opportunity to do right by these consumers. Contrary to what the Journal-Register suggests, state law does not appear to ensure these consumers ‘can’t lose money on their investment’. In reality, the non-guaranteed contract purchaser has investment risk because of the decision to forego the guaranteed contract.  Granted, the consumer may not have been able to afford the guaranteed contract (and its required installment payments).  But, the non-guaranteed contract represents a fund set aside for use at a future date (without promises from the funeral home about what those funds will purchase). 

When a funeral home steps forward to honor a non-guaranteed contract regardless of the deficit, the consumer should recognize that the funeral director is covering the deficit out of a commitment to the family, and not because of a state law.   Consumers of guaranteed contracts should also appreciate that funeral homes are honoring those contracts despite legitimate controversies over their obligation to do so. 

The IFDA and its advisors made serious mistakes, but so did the regulators. Oversight fell through the cracks several years ago. Restructuring the master trust and its oversight could take years. The reform process will only take longer if misplaced criticism must be addressed at every step.

• Email This
• Print
• Comments
• Trackbacks

Has the economy caused consumers to put preneed on a back burner? Perhaps, but funeral directors can anticipate an increase in spend down inquiries. It is hard to turn prospective business away, but funeral directors need to consider how these transactions do not lend themselves to insurance funding or the conventional guaranteed preneed contract.

In many situations, these families cannot afford a full traditional funeral. Over time, they may be able to contribute funds to pay for most of a funeral (depending upon the expense of the casket), but they cannot commit to regular monthly payments. Often, payments may be several months apart. A funeral home cannot freeze its prices if the family cannot commit to paying the required price within a specified time.

But, what are the funeral director’s responsibilities with regard to the non-guaranteed payments? Does the funeral director become a guarantor of the payments received on the non-guaranteed contract? This is one of the ‘lesser’ issues in the IFDA master trust controversy.

Last October, the IFDA included the following explanation on their website:

Non-guaranteed contracts are subject to the ups and downs of the market – like many other investments. Their principal is protected by the funeral director who sold them the “non-guaranteed” preneed policy.

Today, the IFDA website is a bit less forthright about the non-guaranteed contract:

The very nature of a "non-guaranteed" preneed contract is earnings are not guaranteed, but the amount of principal paid by the consumer is protected. The value of non-guaranteed contracts is determined at the time of need and any paid principal is a deposit toward the final cost. If there are any earnings in the Trust investments, those earnings are credited toward the final purchase price. But if there are no earnings, the amount of principal paid is still protected by law and applied on behalf of the consumer to the final purchase price.

Unless the non-guaranteed payments are invested separately in government-backed securities, the consumer will ride with the funeral home in the ups and downs of the market. To suggest the consumer will at least get his deposits means that the deficit has to be funded out of the trusts assets, at the expense of the guaranteed contracts.

Last summer, the Missouri Funeral Directors and Embalmers Association made a POD/bank account proposal during the state’s reform hearings. While the proposal has merit, state attorneys were quick to point out that POD bank accounts cannot be excluded from a consumer’s assets for qualification testing. In other words, you need an irrevocable trust for spend down purposes.

• Email This
• Print
• Comments
• Trackbacks

It has to be bad when your main source tells you its time for the Methadone clinic. With the worst financial crisis in our lifetime, and spiraling costs, what funeral director isn’t already battling a case of the sweats and shakes when reviewing his/her preneed program?   And now you’re being told to go cold turkey on the only preneed transaction that you offer.   

With Forethought having joined the bandwagon against the guaranteed preneed contract, funeral directors are being forced to reexamine the transaction.  It is an examination that is long over due. However, dropping the guaranteed contract will not be as simple as Forethought suggests. 

For fifty years, the US funeral industry has defined preneed as a cost saving transaction that will provide peace of mind to the "consumer".  As many funeral directors recall, Forethought/Batesville taught them how to structure this transaction around the casket sale. And, now they tell the funeral director it’s a mistake. No wonder some funeral directors are a bit miffed with their insurer. Funeral directors that embrace Forethought’s prescribed medicine could suffer sharp withdrawal pains that have long-lasting side effects.   

Preneed insurers are crucial to most preneed programs, but funeral directors need to appreciate that their insurers are responding to changing market forces. Insurers are looking for alternative markets, and consequently, we are hearing more about ‘final expense policies’ and ‘funeral expense trusts’. These products can be marketed independently of the funeral home, relegating the funeral director to an end provider.   For the funeral home that maintains an insurance agency, the final expense product offers a larger commission. But, the final expense product also targets a more affluent consumer. How many of your consumers are candidates for a $20,000 policy that provides a 2% return, and requires a $200+ monthly premium?

Rather than go cold turkey on the guaranteed contract, the industry will begin to explore hybrid contracts that provide partial cost protections. For the older, and less affluent, consumers, the industry needs to look at cooperative trust arrangements similar to those offered in England, Canada, New Zealand and Australia.   With regard to these alternative trusts, we face a 'minor' hurdle: our preneed exemption from certain securities regulations is based on the guaranteed contract being a sale of goods and services. 

To facilitate the administration of preneed contracts and trusts, the Securities and Exchange Commission has issued a series of “No Action Letters” regarding the preneed contract or the preneed master trust. See, e.g., Fleet National Bank (Sept. 5, 1990); Funeral Services of Iowa, Inc. (September 28, 1987); Michigan Funeral Directors Association (August 27, 1987); Associated Funeral Directors Service, Inc. (September 5, 1986); Drexel Trust Company (September 12, 1983).

For purposes of collective investment, the trust-funded, non-guaranteed preneed contract will need to utilize an alternative exemption from the SEC regulations. 

• Email This
• Print
• Comments
• Trackbacks

Regulators and preneed sellers squared off recently over the subject of who owns the preneed trust fund: the funeral home or the consumer. Hearings to reform Missouri’s preneed law hit a wall when the issues of trusting requirements, income accrual and portability was taken up by a review committee comprised of regulators, industry representatives and consumers.  

In a debate that has been waged in countless other venues, several Missouri funeral directors asserted that the trust fund is theirs because they have guaranteed the prices and assumed the risk of the trust's performance.   The regulators argue that the trust fund represents the consumer’s funds, and the consumer should have the right to change their minds about funeral homes and type of service they want, and to do so they must be able to transfer the funds or receive a refund without penalty. 

This all begs the question: what do consumers want?  We cannot answer that question in Missouri because the law only contemplates the guaranteed contract. 

Mortuary Management asked the question whether the guaranteed contract is necessary to attract preneed customers.  As was the case at the Missouri meeting, the responses were divided. 

As Missouri re-writes its preneed law, consumers should be afforded a meaningful choice between the guaranteed contract or the non-guaranteed, 100% funded contract.  As I wrote in one of the first blog entries, the non-guaranteed contract faces certain hurdles.  

Under Missouri's current trusting requirements, preneed sellers have little incentive to offer a non-guaranteed contract.   If the funds are deemed to be entirely the consumers', who will assume the burden of establishing a program that provides the requisite documents, administration and oversight?   

• Email This
• Print
• Comments
• Trackbacks