Search results for: qualified funeral trust

If the President signs the Hubbard Act (H.R. 6580), the qualified funeral trust will have the capability to fund all of an individual’s final expenses. When enacted, Section 685 imposed a $7,000 cap on the preneed trusts that could elect special tax treatment. While the limitation increased annually, the cap was too low to permit funding of funeral and cemetery contracts. The cap also precluded cash advance related expenses from being included in many preneed contracts. The Hubbard Act may open the door to allow the Qualified Funeral Trust to become more of a final expense trust. 

The Hubbard Act would amend Section 685 for the 2009 tax year. We will need to wait for IRS guidance regarding any retroactive application of the amendment. However, the Hubbard Act would not impact the requirement that the trust must make a payout within 60 days of the beneficiary’s death.

It is interesting to note from the Congressional record that most trustees probably prepare the 1041 QFT without individual sub accounting. With regard to the Hubbard Act, the Congressional Budget Office reports that the Joint Committee on Taxation (the JCT) estimates the elimination of the QFT limitation will increase tax revenues $6 million over the next 9 years. This estimate is based on the assumption that trusts will produce more income that will be taxed at the higher rates. 

A 1041 QFT will be taxed at the lowest rate (15%) until its income exceeds $2,150. The next tax rate (25%) applies until the trust income exceeds $5,000. Assume the QFT maximum for 2008 ($9,000), and the trust has to have a return of nearly 24% before the second lowest tax rate is reached. If one were to assume the 1041 QFT has a trust of $25,000, the trust has to have a return of 8.6% (net of trustee fees).   Obviously, the JCT are looking at numbers that indicate that trustees are preparing the QFT without individual sub accounting. OUCH!

Assume a $3,000,000 preneed trust with 500 preneed contracts earns net income of 5%, or $150,000. With individual sub accounting, that trust’s 1041 QFT should have an approximate tax liability of $22,500. Without individual sub accounting, that same 1041 QFT will have an approximate tax liability of $51,543.50.   Even with the elimination of the Section 685 cap, the tax liability of the QFT with individual sub accounting will likely be taxed at 15%.   The difference equates to nearly 1% of the trust, or a good argument for better individual sub accounting.

The principal purpose of the Hubbard Act is to provide benefits to the survivors of soldiers killed or severely injured.   I doubt it was coincidental that taxes from preneed trusts will be used to offset the costs of helping a soldier’s survivor build a new life.

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.   

Late in 2021, PNC Bank threw in the towel.  After years of litigation and two appeals, PNC Bank agreed to a settlement with the NPS special deputy receiver.  Last month, our Illinois clients began receiving POC notices from the SDR that a portion of their claims for inflation would be honored.  Payment of funeral home POCs signals the beginning of the end of the NPS receivership.  This got us to thinking about the impact of the NPS court decisions on preneed trust administration.  The watershed finding for PNC Bank’s liability was that provider funeral homes are beneficiaries of a third party seller preneed trust.  In states other than Missouri, the provider funeral home must be a party to the preneed trust and have always been owed duties by the trustee.  But because Missouri preneed law authorizes third party preneed sellers, those types of entities have excluded the provider funeral home from being a party to the trust.  So for Missouri’s remaining handful of third party sellers, the NPS appellate decisions are game changers.

Most states’ preneed laws define a preneed seller to be a licensed funeral home.  Common sense suggests that the entity with the obligation to perform the contract will be diligent in safeguarding the consumer’s funds.   While states allow the funeral home to employ an agency to market, sell and administer consumer funds, they will not allow an independent entity to step between the funeral home and the consumers’ funds.

Missouri was in that same boat until 1982.  That law change had been lobbied by National Prearranged Services and Funeral Security Plans, companies which acted as preneed sales agencies for funeral homes in various states.  The key change sought by NPS and FSP was the definition of a preneed seller.  If the seller was no longer required to be a licensed funeral home, an independent entity could control the entire preneed transaction.  In the 1980s’, the trust funded preneed was king, and these future third party sellers wanted control over the trustee.  It was described to this author as the golden rule: he who controls the gold will rule.  By controlling the funding arrangement, the third party seller would also control the funeral home provider.  Using a separate funeral home provider contract to set out the terms of preneed contract performance and payment, a seller could exclude the provider funeral home from trust management and investment oversight.

When sued for its role in the NPS collapse, PNC Bank argued that claims made by the SDR on behalf of provider funeral homes were inappropriate because they were not beneficiaries of the NPS trusts.  PNC Bank cited the court to Chapter 436, and argued the position that NPS had taken with funeral homes for decades: funeral directors have no rights under our trusts.  In the first civil trial, the court erroneously allowed tort claims to be asserted.  Those tort claims resulted in large damage awards against PNC Bank that were eventually overturned in the first appeal.   When the case was remanded to the trial court, the issues were narrowed to breaches of fiduciary duty, and the trial court ruled that NPS’ provider funeral homes were beneficiaries of the trusts.  PNC Bank appealed again.  In the decision filed in August 2017, the Eighth Circuit agreed with the trial court and turned the third party seller trust argument upside down.  By affirming provider funeral homes to be trust beneficiaries, the appeals court superimposed the Missouri uniform trust code on to Missouri preneed trusts and the seller/provider relationship.

For four decades, third party preneed sellers have told disgruntled provider funeral homes to go pound sand.  A seller like NPS could cite the seller/provider agreement to deflect the funeral home’s demands for information.  The Eighth Circuit changed all of that.  Because preneed trusts make distributions to the provider funeral home, the Missouri uniform trust code deems it to be a “qualified beneficiary”.   As a qualified beneficiary, a provider funeral home can side-step the seller’s stonewall and request an accounting from the trust’s fiduciary.  If NPS provider funeral homes had made accounting demands on Allegiant Bank, their top management may have looked closer at NPS’ actions.

If a third party seller can no longer isolate a trustee from the disgruntled funeral director, will a bank or trust company accept a Missouri third party seller trust?

There seems to be some confusion in Missouri over the permissible contractual relationships among the preneed seller, the preneed trustee and the independent investment advisor. Prior to the collapse of NPS, and the subsequent amendment of Missouri’s preneed law, Chapter 436 allowed the preneed seller to incorporate provisions in its preneed trust agreement to instruct the trustee to hire the independent investment advisor designated by the seller. As discussed in a prior post [Investment Advisors: How Independent?], this provision, and the authority to establish a third party seller, was sought by the Missouri Funeral Directors Association for a new master preneed program. With Senate Bill No. 1, the Missouri Legislature sought to close the 436.031 loop hole that NPS exploited. With Section 436.445, the Legislature prohibited the preneed trustee from delegating investment decisions to any agent of a seller other than an authorized external investment advisor in compliance with Section 436.440. With Section 436.440.2, the Legislature set out the duty of care owed by the trustee when delegating duties and powers. With Section 436.440.5, the Legislature overrode Uniform Trust Code provisions which would allow the trust agreement to relieve the trustee from liabilities arising from delegated duties. The last paragraph of Section 436.440 grandfathered trusts in existence on August 28, 2009 that were using an independent financial advisor.

The confusion stems from whether the grandfather clause of Section 436.440 exempts pre-SB1 preneed trusts from the duties set out in the prior paragraphs of that section. When the State Board staff sought the Board’s approval of proposed regulation 20 CSR 2120-3.525, the Missouri Funeral Directors and Embalmers Association objected on the basis that the regulation exceeded the Board’s statutory authorities. The Association’s executive director asserted that the regulation would override the grandfather clause of Section 436.440.6. What the Association seems to be saying is that the grandfather clause allows a pre-SB1 trust to continue to treat the seller as the sole beneficiary, and thereby limit the duties owed by the trustee and the independent investment advisor to funeral homes and preneed contract purchasers. That is a very extreme reading of a very vague paragraph.

Contrary to what the Association’s executive director has asserted, the proposed regulation would not override the grandfather clause. The regulation would allow the master trust program to continue to use its investment advisor so long as the advisor remains qualified and the agency agreement between the trustee and the fund manager complies with the regulation. The grandfather clause cannot be read as giving the master trust program carte blanch to define the duties owed to provider funeral homes and preneed consumers.

The NPS civil trial has completed its third week, and jurors probably face another four weeks of witness testimony.  First from the NPS receiver, and then from the defendant trustees, the jurors are hearing two very contrasting theories of what fiduciary duties were owed by the NPS trustees.   Up until a few weeks before the trial began, the defendant trustees defined their fiduciary duties as owed exclusively to the preneed seller (which for the most part was NPS).  But the court ruled in favor of the NPS receiver, and found that the consumers and funeral home providers were also trust beneficiaries, and therefore owed fiduciary duties.

Pleadings filed with the court suggest that the SDR’s arguments will be focused exclusively on duties owed to consumers and funeral home providers.  The defendant banks will seek to demonstrate that procedures were developed in compliance with the requirements of Chapter 436.  The elephant in the courtroom will be the failure of a billion dollar preneed company, and the exposure of tens of thousands of consumer contracts.   The receiver will argue to jurors that such a failure had to be the result of fiduciary negligence.  To an extent, the court has provided some support to this argument.   In an evidentiary ruling, the court held that the defendant banks could not introduce evidence for the purpose of showing that regulators bear some fault for the NPS collapse.  However, the court left open whether he will allow the introduction of evidence regarding regulatory actions for other purposes.   Consequently, we anticipate that the defendant banks will introduce evidence of regulatory actions for purposes of establishing standards that the trustees subsequently followed.   If regulators and bank trustees did all that was required by Chapter 436, preventing the Cassitys’ fraud was not a failure on their part, but rather a failure of Chapter 436.

Missouri trust treatise law was authored in part by Professor Francis Hanna.  Professor Hanna was qualified as an expert by the court to testify at the civil trial, and his expert witness report methodically examines the fiduciary duties of the Missouri preneed trustee, and the fiduciary claims made by the NPS receiver.  In subsequent posts, we will examine the duties as outlined by Professor Hanna.

Among the rule proposals suggested by the Division of Professional Registration to the State Board of Embalmers and Funeral Directors was the following definition of “External Investment Advisor”:

any licensed, qualified investment advisor approved and authorized by the trustee of the preneed trust and who holds no personal interest in any assets of the preneed trust and has no financial relationship, business or personal, with any person or entity who has any relationship, business or personal, with the preneed seller such as to create or give the appearance of showing a lack of independence.

The definition reflects the Division’s intent to establish a Chinese Wall between a preneed seller and any independent financial advisor (external investment advisor) retained by the preneed trustee.   As background, Section 436.440 of SB1 was probably sought by Missouri Regulators to preclude preneed trustees from using financial advisors independent of the bank.  (We explained this in the blog post titled “Regulating out of context”.)  The Missouri funeral directors association countered that section with legislation that amended Section 436.445 to add “external investment advisors” to the permissible agents that a trustee could retain as an agent.  So now, the Division seeks to counter that legislation with a rule proposal.

For reasons discussed in “Preneed Fund Manager: Is your O&E coverage current?” and “The Zeal for Independence: The NPS Investment Advisor”, we believe the Chinese Wall approach is short sighted and inappropriate.  As an agent of the trustee, it can be argued that the investment advisor assumes a fiduciary duty to learn the ‘client’, and as discussed in the referenced blog posts, that includes the seller.  If a trustee and the investment advisor desire to document investment policies with the seller’s consent, would that represent a business relation, or a lack of independence? 

The definition is not only vague and ambiguous, it is also inconsistent with the Uniform Trust Code.   With the engagement of an independent investment advisor, the trustee may want to include the seller as a party to the advisor’s engagement agreement.  That agreement can then define their mutual duties with regard to disclosures and investment objectives.  

On January 14th, Missouri Governor Jay Nixon will be sworn in for his second term, and we are wondering whether the Governor’s plans for 2015 are influencing the direction of Missouri’s preneed reform. With commentary such as that published by the St. Louis Post Dispatch, the Governor may have his eyes on a 2015 campaign for national office. At a minimum, Governor Nixon could be targeting an old rival’s U.S. Senate seat. Either way, the Governor faces a nagging situation with NPS, and may feel compelled to accelerate preneed reform and deflect the criticism that has persisted for almost five years.

When National Prearranged Services collapsed in 2008, NPS funeral providers were especially critical of how then Attorney General Nixon settled the 1991 NPS lawsuit. The Attorney General’s office responded that they did the best possible with the weak enforcement powers provided by Chapter 436. Missouri’s Republican administration countered with a review committee formed for the purpose of finding industry consensus for preneed reform. But, the industry struggled to agree on key issues, and the State’s regulators took the lead in drafting Senate Bill. No. 1. In 2009, a newly elected Governor Nixon inherited the NPS fallout and a prior administration’s effort at preneed reform. Now four years later, the NPS fallout has somewhat abated (but not resolved), and there isn’t much to show in terms of preneed reform.

In contrast to the mortgage crisis or the state budget crisis, the NPS situation will not benefit from the recoveries of the nation’s economy or the financial markets. The Cassitys’ emptied the cupboards, and funeral homes are dependent upon the fixed recoveries negotiated with the state insurance guaranty fund. Most NPS providers are finding ways to cope, but one industry group persistently reminds the Governor and legislators of their discontent. The Governor would like to counter their criticism with evidence that preneed has been made safer under his watch, but it can take years to implement effective reporting and examination procedures.

As we noted in July 2011, a sudden increase in the number of financial examinations suggested that the Division was being pressured to accelerate the process. Shortly thereafter, the Division staff also began to press the State Board to define the insurance assignment as a preneed contract. The State Board and the Division staff disagreed on the insurance assignment issue, and frustration began to develop as the issue was pressed in subsequent meetings. That frustration culminated with a December 12th unanimous vote by the Board members to define insurance beneficiary designations as a preneed contract, but a preneed contract that would be exempt from the $36 preneed fee. Division staff warned that the distinction may not be legal. Within hours of the vote, the Governor’s office announced a Board appointment to replace Todd Mahn, the Chairman who had called for the vote.

The Governor’s website for Missouri’s Boards and Commissions states

"I am always looking for qualified, energetic applicants to serve on Missouri’s 200-plus boards and commissions. Please spread the word. I would greatly appreciate it if you would encourage your colleagues and friends to review the vacancies and complete an application."

While this author has disagreed with some of the positions taken by Mr. Mahn, I do not question his commitment to the industry, or to the State Board. Nor did the former Chairman lack for enthusiasm and energy while serving the Board. But, rather than replace a Board member with known health issues that was serving on an expired term, the Governor replaced the younger Chairman.

It may not have been the Governor’s intent, but the appointment could be taken as message to State Board members to ‘get with the program’. But the Governor, and the Division, risk losing the confidence of both the Board and the industry. Someone has lost sight of the first issue discussed at the 2008 legislative meetings: who should have jurisdiction over preneed. Several state agencies attended that meeting, and none expressed any interest in assuming jurisdiction over the preneed transaction. As explained in a 2009 post, financial and insurance regulators often struggle to provide effective preneed oversight because they tend to focus on the ‘backend’ of the transaction (that part of the transaction they are most familiar). The front end of the transaction can take many different forms, which can push the transaction outside the normal scope of the agency’s jurisdiction. (For example, the Nebraska Insurance Department has jurisdiction over preneed sales, which includes trust funding.) When State Board members ‘stepped up’ in 2009 to retain jurisdiction (and demonstrate that the industry could provide meaningful self regulation), a collective sigh could be heard from the Missouri Division of Finance and the Missouri Department of Insurance. The Missouri legislature signed off on State Board jurisdiction, and in doing so made a trade off: reform would rely upon the collective experiences and training of six State Board members instead of an appointed department official. Governance by a board will never be the most efficient or expedient path to action.

In SB1, the State Board was given the task of protecting consumers against another NPS by developing procedures for preneed reporting and auditing. However, the Board is dependent upon the Division of Professional Registration for staffing, legal counsel, funding and reporting administration. Together, the Board and Division crafted a mission statement for the financial examinations that was to be the cornerstone of Missouri preneed reform. From this observer’s perspective, the State Board members never understood how the insurance assignment fit in to that mission statement. Explanations given to the State Board were unpersuasive, leaving an industry to wonder whether the issue was fee driven.

It may have taken the State Board a year to reach an agreement on the insurance assignment issue, but we believe the Chairman made the right call. This issue had a greater importance to the Division than it did the State Board, and there is speculation that the $36 fee, Chapter 208 and the state budget played a factor. Regardless, a resolution was needed so that the Board and the staff could turn to more substantive reform issues, including whether SB1 provides sufficient audit powers and protections. If the Division can look no further than the funeral home’s records, would SB1 have even stopped NPS?
 

In the days that followed the Wisconsin Funeral Directors Association being placed into receivership, some of the WFDA’s sister associations were quick to point out they had ‘checks and balances’ that would protect consumers’ funds from the problems that tripped up the Wisconsin Funeral Trust. As we reported in our last post, a crucial ‘check and balance’ missing from the WFT was investment oversight. The fact that a trust has a corporate trustee does not necessarily mean that fiduciary has responsibility for monitoring the prudence of the investments. Corporate fiduciaries often look to uniform trust codes for the authority to delegate investment responsibilities. If a grantor wishes to use an outside asset manager, general trust laws will accommodate those wishes. The problem with preneed trusts (and cemetery endowment funds) is that there is more than one “grantor” to the preneed trust.

We have previously stated our support for allowing a relationship between preneed seller and a qualified fund manager. However, the fiduciary must provide a ‘check and balance’ to that relationship by maintaining responsibility for the investments. The ‘scandals’ from Missouri, Illinois, California and Wisconsin stem from a lack of investment oversight. Missouri’s regulators responded to NPS with a law that precluded any relationship between the advisor and the seller. Appropriately, the Missouri association obtained revisions to allow an agency relationship between its fund manager and the trustee. However, the Missouri law does not go far enough to require the disclosures we recommended in 2011. Funeral directors and consumers need to know that Missouri preneed fiduciaries ‘have their back’ when it comes to investment oversight.

Investment oversight is also a concern for cemetery regulators. Kansas’ cemetery regulators were dismayed to find that a corporate trustee had turned over the investment reigns to a Hutchinson cemetery operator. The operator hoped to cover declining revenues (and the failure to make trust deposits) with higher investment returns. For months, the operator attempted to hide the ball from the auditor, but eventually it was discovered that those investments had lost hundreds of thousands of dollars.

The investment supervision issue is also a concern for Nebraska regulators. As they prep the death care industry for legislation in 2013, they raise this issue:

Seller’s Power to Direct Investments

A question has arisen regarding the seller’s ability to direct the trustee’s investment decisions. Specifically, should the seller be able to instruct the trustee to deposit or invest funds in securities that do not meet the trustee’s own investment guidelines?

If it is determined that the trustee should be free from the seller’s investment influence, section 12-1107 should be amended to reflect this fact.
 

In what may be a perfectly legal arrangement, Illinois funeral directors have handed off investment oversight to their new fund managers. The master trust instrument carefully outlines the code provisions which authorize the delegation of investment authorities. But the document goes that extra step of exculpating the trustee from responsibilities for investment oversight. Where is the check and balance in that structure? Are the industry’s expectations so high that a trustee will not accept the fund without a hold harmless? If the industry does not establish its own ‘checks and balances’ with regard to investment supervision, the authority to participate in the investment decisions could be taken away.