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

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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It's always an ugly scene when a party to a fiduciary relationship gets caught with his/her hand in the cookie jar.  Unfortunately, this has been happening with alarming frequency in the death care community, and Indiana has had enough.  In a relationship that requires mutual cooperation, the death care industry has taken the position that "someone should have stopped us by saying no", and the Indiana legislators have agreed.   With the legislation signed into law last week, Indiana has initiated a major shift in the responsibilities of the death care fiduciary.  Like the tree falling in the forest, was there anyone from the banking/fiduciary community around to here it?

The Indiana legislature moved quickly in response to the trust frauds committed at Grandview Memorial Gardens and at the cemeteries owned by Robert and Debra Nelms, and Governor Daniels followed suit by signing HB 1026.  The new law will go into effect July 1, authorizing the Indiana State Board of Funeral and Cemetery Service to promulgate regulations that will determine the distribution documentation that must be reviewed and approved by death care fiduciaries.  Failure to comply with these new requirements will expose the fiduciary to criminal charges and liability to cemetery customers. 

 To understand the gravity of the issue, fiduciaries need not go any further than their clients for input.  The general counsel for the Indiana Cemetery Association put it this way:

The people who own the trusts could do almost what they wanted. We've given the trust companies the incentive not to pull the wool over their eyes.

Cemetery association members were aghast to learn of the case because they did not understand the extent that the current law left cemetery trusts vulnerable. People really weren't aware. 

It would be safe to say that most death care fiduciaries are still unaware how vulnerable these trusts are.

What should death care fiduciaries do?  The knee-jerk reaction would be to terminate such accounts and run as far away as possible.  However, the fraudulent character of the charges leveled in recent class-action suits bring into question whether the statute of limitations has even begun to run.  The class-action lawsuit brought on behalf of Grandview Memorial Gardens lot owners will likely turn on whether preneed contracts were performed pursuant to their terms, and that will require the distasteful act of opening gravespaces.  The trust frauds committed by the Nelms have already snared one fiduciary and a major brokerage firm when a $20 million class-action lawsuit was filed in late January on behalf of cemetery lot owners. 

Fiduciaries with a federal charter may be tempted to play the federal preemption card that has been used to keep state regulators at bay with regard to the sub prime mortgage crisis, but history is not on the national fiduciary's side with regard to death care regulation.  State death care regulators in Florida and Texas have taken OTS preemption opinions, rolled them up and slapped thrift chartered fiduciaries into submission.  Frankly, the legal arguments advanced by the state regulators were on point.

Indiana chartered fiduciaries need to become engaged in the procedures that will be unfolding before the Indiana State Board of Funeral and Cemetery Service later this Summer.  The death care industry will be there in force providing their comments about the forms and procedures to be covered by the regulations authorized by the new law.  Fiduciaries will have no one but themselves to blame if they miss this dance. 

Federally chartered fiduciaries will need to determine how significant a block of business Indiana represents to their death care business.  These fiduciaries will also need to monitor other states to see whether the Indiana law represents a trend that other state legislatures will follow. 

Death care companies and consumers will need to anticipate an increase in the cost of fiduciary services.   The old adage "you get what you pay for" has a double-edged application to the death care fiduciary environment.  The security sought by consumers and cemeteries/funeral homes will come at a cost.  To minimize the cost of the new obligation to provide distribution oversight, death care companies and fiduciaries will need to explore standardized examination procedures or the reliance on established audit procedures.   Death care companies will also have to be more receptive to trust instrument provisions intended to provide fiduciaries the power to say no, and protections when they do.

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Whether it is because of state law restrictions or preneed purchaser demographics, death care trusts have unique requirements when it comes to investments.  Consequently, it is fairly common for a death care trust to utilize an investment advisor who has experienced with the industry.  However, the deductibility of the fees paid to outside advisors by death care trustees will now be more closely scrutinized in light of a January 16th decision handed down by the US Supreme Court in the case titled Knight vs. Commissioner.   

The conflict over the deductibility of investment advisor fees developed within the context of estate planning trusts, and has been brewing since 1993 when the Sixth Circuit rejected the IRS' position in O’Neill vs. Commissioner of Internal Revenue, 994 F.2d 302.  In subsequent cases in other circuits, the IRS prevailed in its application of IRC Section 67(a) and the 2% floor.    Like side catch in a commercial fishery net, death care trusts are being pulled into a controversy based on estate planning facts. 

The impact of this issue on some death care trusts is felt not so much by the 2% floor, but by a collateral issue: the alternative minimum tax.  For maintenance trust returns, the characterization sought by the IRS renders the advisory fees fully taxable. And, the arguments forwarded by the IRS in its briefs to the Supreme Court and the lower courts suggest that the Service may look at other types of services outsourced by the fiduciary.   

The Supreme Court left the door cracked for the full deductiblity of fees paid to trust service providers, but the death care companies will have to work with their fiduciaries to justify the deduction of such fees.  To defend the deduction, the parties have to start with their trust instrument and administration documents to define the services and justify their need.   

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The National Funeral Directors Association has taken the lead in getting legislation introduced to eliminate the dollar cap imposed on qualified funeral trusts.  While I hope the NFDA succeeds, it won't be without a fight from the IRS. 

As the death care industry inches towards the non-guaranteed preneed transaction, the IRS will express its concerns over abusive trusts.  While funeral directors ponder whether consumers will embrace a preneed transaction that does not provide price guarantees, the IRS will question whether the transaction will be abused as a tax shelter. 

The Section 685 needs to be increased substantially, but I anticipate the Service will pull no punches while fighting the NFDA's efforts.   

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