Earlier this year, the New York Times ran a story that on funeral planning that raised several valid issues and recommendations. We will use the next few blog posts to explore certain issues and recommendations in greater detail. With this post we will start with the article’s discussion of prepaying for a preneed contract, and the differences between guaranteed and non-guaranteed plans.
The article references one side of the consumer protection argument against prepaying preneed arrangements. That argument is that everyone should preplan their funeral, but an individual should not purchase a preneed contract until forced by Medicaid eligibility requirements. (To qualify for public assistance, consumers often purchase an irrevocable preneed contract. These arrangements are called spend downs.) Until Medicaid is an issue, the article’s sources recommend that individuals establish an investment account or depository account that they can control.
The AARP offered another view of prepaying a preneed contract that the Times article does not discuss. As the AARP explained in a 2010, a guaranteed preneed contract can protect families from rising funeral and burial costs. Funeral costs have risen substantially over the past decade. The rate of cost increase varies with funeral homes. But the range of rates is estimated to be more than 3%. Money placed in a depository account at the local bank is currently earning less than 1%. So, costs are outpacing the savings account by at least 2%. In ten years, a $10,000 funeral and burial package will cost $13,000. The bank account has grown to $11,000, leaving survivors to pay for the balance. That simple math makes the guaranteed preneed contract an attractive option for the individual who knows what type of funeral service they want, and what funeral home they want it from.
As the Times article explains, a guaranteed preneed contract is an arrangement where the funeral home uses today’s prices for a funeral to be provided at a future date. In contrast, the non-guaranteed preneed contract makes no promises about the future costs of the funeral. The non-guaranteed contract is more of a savings account that will be used at death. From a funeral director’s perspective, the key difference between the two types of contracts is that the funeral home assumes the investment risk for the return paid on the consumer’s funds.
Funeral homes use one of three types of preneed investment vehicles: insurance, trusts and depository accounts. With insurance funding or depository accounts, the funeral home is challenged to find any investment efficiencies. Funeral homes that use depository accounts are receiving the same rates that individuals can get, less than 1%. Individual CDs are typically required by state law, and funeral homes are often restricted to short term CDs. So, no jumbo rates are available. Preneed insurance companies are paying a slightly higher rate, but often with various limitations. The death benefit is often limited during the first few years of coverage. Most preneed insurers are currently paying under 2%.
Trusts have the opportunity to provide higher returns when investments are properly diversified and the trustee expenses are reasonable. But, many funeral homes are opposed to pooling their trusts for investment, and as consequence, do not see a return that will cover cost increases. So regardless of the investment vehicle, funeral homes experience an investment shortfall when servicing a guaranteed preneed contract.
For the consumer that knows the funeral they want, and what funeral home to use, the guaranteed preneed contract can have a cost saving benefit that justifies prepayment. For the consumer that appreciates the need to begin planning but has not committed to a specific service or to a particular funeral home, the guaranteed contract has disadvantages. When transferring to a different funeral home, the new funeral home may not be obligated to honor the prices in the contract. Some state laws allow the funeral home to retain termination fees.
Many funeral homes are shying away from guaranteed preneed contracts because of investment losses, and are offering non-guaranteed contracts. When offered a non-guaranteed contract, the consumer should ask certain questions to determine whether to prepay for that contract, or to establish the type of depository account described in the Times article.
- What form of funding does the funeral home use?
- Will the funeral home waive any termination fees or transfer fees?
- What type of return has the funeral home received on its preneed funding over the past 5 years?
- Using the funeral home’s most popular package, how much does it cost today and how much 10 years ago?
If a funeral home offers depository accounts as the funding option, any fees charged by the funeral home would probably dictate that the consumer follow the advice in the article and set up their own POD account. If the funeral home offers insurance funding, limitations such as return of premium and a low death benefit increase would also suggest a POD account might be better. If the funeral home uses a trust, determine whether the investment return covers funeral home costs. It would also be beneficial if the funeral home waived all fees so that the non-guaranteed preneed contract would be completely portable.
Another consideration is whether the consumer will be funding the non-guaranteed contract over time. Funeral homes that offer only insurance funded contracts may not be able to accept multiple payments. This could also prove a problem for funeral homes that use certificates of deposit.