On January 30th, the Nebraska Legislature will conduct a hearing on a bill to fix a problem with the state’s preneed funeral law. The Burial Pre-Need Sale Act was originally passed in 1986, when preneed trusts invested almost exclusively in government bonds. The intent of the Nebraska law was to require the preneed seller (that used trust funded contracts) to deposit 85% of the preneed contract payments into trust, and to thereafter, require the trust to accrue income each year equal to the CPI published by the Department of Insurance. In years where the trust earned more than the CPI requirement, the preneed seller could withdraw the excess income. The law included the following definition:
(23) Trust principal shall mean all deposits, including amounts retained as required by section 12-1114, made to a trust account by a pre-need seller less all withdrawals occasioned by delivery or cancellation
This definition would eventually prove to be problematic. Banks have their own definition of “trust principal”, which is the same as tax cost basis. Nebraska’s annual report failed to make a distinction between the statutory definition and the bank’s trust principal, and incorporated the bank’s reporting of trust principal. So long as a trust holds a bond to maturity, there is little difference between the two definitions. However, a bank’s trust principal includes all characters of income, and trust principal will be reduced when capital losses are realized. And that is what several Nebraska preneed trusts experienced in 2008 and 2009 when the bond mortgage crisis occurred.
From the Department of Insurance’s perspective, capital losses from bond selloffs represented a double threat to the funding adequacy of the state’s preneed trusts. Not only were trust principal’s declining, CPI requirements were declining with trust principal. Consequently, the Department began to revise the annual report away from the bank’s definition of ‘trust principal’. Over the course of five years, the Department tweaked the annual report, incorporating market value factors and unrealized gains/losses factors. For preneed sellers that had not incurred significant capital losses, the annual report revisions inflated their CPI requirements, and reduced their excess income withdrawals. Accordingly, Bill LB239 is a welcomed return to law’s original intent.
Nebraska’s larger preneed sellers will want to know how the Department will adapt the annual report for trusts invested for a total return, rather than an income return. Ten years of a Federal Reserve interest rate at near 0% have forced many preneed trusts to switch to a total return investment policy. The market performance over the past 12 months has been robust, but fueled by rising equity values, not interest income. Preneed trusts may experience a 4% investment return, but only a 1.5% net income return. When the CPI is at 2%, the total return looks good and the net income return not so good. But, the Legislature’s intent has been met: if all preneed contracts were to be canceled or performed today, the trust has market value in excess of trust principal/liability.
Another question is whether the Department will continue to use the trust’s market value as the benchmark for the adequacy of funding. A return to the use of the bank’s definition of trust principal as the benchmark could result in situation that Missouri Legislators rejected 20 years ago. Prior to 2009, Missouri’s preneed law allowed sellers to withdraw excess funds so long as the trust’s market value exceeded trust deposits. When bond values fell in the mid-1990s, preneed sellers were caught off from excess funds withdrawals. The industry proposed legislation to allow government bonds to be held at cost rather than market value. The legislation was rejected, and bond values recovered before the industry could seek another chance at the legislation. The criticism made of the bill was that it would encourage sellers to have trustees hold on to ‘dog’ investments when market conditions recommended changes.