When the Federal Reserve recently announced the end of the quantitative easing program, it did so with a hint that any increase in interest rates could be a considerable time off. Several global factors may now cause interest rates to remain at unprecedented lows for longer than what the Fed had suggested last December. As we’ve discussed in a previous post, interest rates have now been below preneed performance cost increases for more than 10 years. The continuation of that circumstance will fuel industry discussion of preneed shortfalls, non-guaranteed contracts and/or guaranteed contracts that include a price protection “bump”. In examining whether to sell (or purchase) a preneed contract with a price protection bump, operators and consumers need an understanding of the factors that contribute to preneed shortfalls:
Five Factors That Lead to Preneed Shortfalls
- a) Investment Return
- b) Operator’s Performance Cost Increases
- c) Duration of the Preneed Contract
- d) Duration of Installment Payments
- e) Sales Expense/Commission Retained
In the most basic of terms, the investment return must exceed future costs to perform if the preneed transaction to be profitable for the funeral home. While performance cost increases will vary from funeral home to funeral home (except for consolidator owned establishments), it is safe to assume most operators are experiencing cost increases in excess of 2%, a rate which trusts and insurance are struggling to provide. For purposes of demonstrating the preneed shortfall, assume a preneed contract is paid with a single premium, the investment funding provides a steady net 2%, and the contract beneficiary lives ten years. Depending upon the funeral home’s individual performance cost increase, the preneed shortfall could be between $460 and $1960, or more.
We will look at the other factors in more detail in future posts, but the funeral home’s preneed shortfall will be greater if the purchase price is paid in installments, or the contract beneficiary lives longer than 10 years, or a portion of the sales price was retained as sales expense in a trust funded arrangement.