Prior to Missouri re-writing its preneed law in 2009, preneed sellers could draw off realized income so long as the withdrawal did not reduce the trust’s fair market value below trust deposits.   Seeking income, many Missouri sellers directed their trustees to invest in bonds.  As interest rates declined during the early part of the prior decade, bonds with higher yields climbed in value.  However, replacing those yields with new bonds became difficult, and then impossible (with the subprime mortgage collapse in 2008).  A trustee would have to pay a premium for a bond with the rate that sellers sought.  Today, many of Missouri’s older preneed trusts are left with a cupboard of long duration, lower yield bonds that are very susceptible to market volatility.  When the Federal Reserve does eventually begin to raise interest rates later this year, bonds with longer durations will experience a fair market value erosion.  If an older Missouri preneed trust has a resulting ‘shortage’, that exposure will likely be due to a trustee having sit on a bond portfolio while the seller continued to pull out interest income.  This is primarily an old trust problem because the new law now requires income to be accrued until the cancellation or performance of the contract.  (Sellers that combined their pre and post SB1 contracts in the same trust may have another set of problems.)

It has not been our experience that the financial examiners seek information to determine if a seller’s trust has been making income distributions, and how the trustee documents compliance with the prior law’s “mark to market” requirement.  Such distributions could be documented with the trust’s current fair market value, gross income year to date, gross trust expenses year to date, any reserve for income taxes, income distributed year to date, and the income to be distributed.

So long as the seller and trustee appropriately apply the brakes to income distributions before the fair market value hits the deposit balance, a subsequent shortage resulting from a market decline should not trigger the seller’s liability to contribute funds.  Failure to anticipate the market’s decline, could leave the trust in a prolonged shortage that could require future distributions to be based on fair market value (ie, on the performance of a contract, sellers would receive less than the contract’s deposit balance).

At its June meeting, the Missouri State Board of Embalmers and Funeral Directors gave instructions to their staff to draft legislation that would provide the Board powers to force preneed sellers to contribute funds to their trusts to cover ‘shortages’.   The instruction was not without some controversy as one Board member questioned why he was required by his preneed examination to fund shortages from preneed contracts that he had assumed through a funeral establishment acquisition.  The explanation of “it depends on the acquisition document” provoked some confusion.   Through the discussion by the Board, the staff and the public, it was generally agreed that the seller is not a guarantor of investment performance, and therefore should not be responsible to fund market value drops.  But, as witnessed by other states’ master trust problems, there are a score of other sources for trust ‘shortages’.  Consequently, the staff’s attempt to define those ‘shortages’ that a seller will be held liable for funding will come under close industry scrutiny.  And based on comments offered by its executive director at the state convention, the Missouri association’s master trust may be at the front of the line to voice objections.

Intended as demonstrations of strength, a convention audience was advised that if all Missouri master trust contract holders were to die that day, the program would be left with a surplus of about $3 million dollars.  And, if all contracts were to cancel that same day, the program would be left with a surplus of about $7 million dollars.  Any statement that suggests a common trust fund would have a ‘surplus’ warrants  regulators’ questions, but we will explore those issues another day.  However, if the cancellation ‘surplus’ and representations made about the size of the trust’s assets ($63 million) are accurate, then the program likely has a significant number of individual preneed contracts with a fair market value near  their deposit balance.   But, the association master trust will not be the only Missouri seller with preneed contracts that are on the cusp of a “shortage”.

The first round of Missouri preneed financial examinations is now being completed and our experience with seller clients has been their examination reports seek an explanation for each contract that has a market value below the required deposit balance.  This can be particularly frustrating when the ‘shortages’ are on small number of contracts that amount to a few dollars each.  These inquiries may reflect either a lack of understanding by the examiners, or a lack of adequate trust information.  Consequently, it may be time to look at the different sources of trust shortages and the information provided by sellers and trustees, and then to establish guidelines for the next round of preneed financial examinations.

According to court filings, the reorganization plans for the Wisconsin Master Trust and California Master Trust each seek to eliminate ‘de facto trustee’ relationships that allowed the respective associations’ executives to ‘misuse, misspend, and mismanage millions of dollars’ of trust funds, and to direct funds towards inappropriate and unsuitable investments that served the association’s, rather than the beneficiaries’, goals.   The receiver for the Wisconsin Master Trust laid responsibility for abuses of that trust at the feet of the association, and reported to the court that:

The Trust was hemorrhaging from the costs it was incurring. We promptly eliminated between $50,000 and $100,000 per year in administrative costs, $125,000 per year in investment advisor fees and $240,000 per year in payments to the WFDA and its affiliate. We also eliminated a large amount of other fees that did not appear on the Trust’s records but that were built into securities transactions.*

The trust agreements proposed to courts in California and Wisconsin would reinstate the trustee’s duties with regard to investment compliance, controlling trust expenses, and to severe the association’s use of master trust funds.  Consequently, it seems odd that executives for the Missouri Funeral Trust would use the circumstances of the Wisconsin and California master trusts to distinguish their own program, and to then file a lawsuit declaring confidential and proprietary all trust documents, client lists and investment contracts.  Sources report that while attending the Missouri Funeral Directors and Embalmers Association convention a few weeks ago, master trust representatives declared the program had “deep pockets” and could afford to sue to protect its interests and client relationships.  If trust assets are being used to finance the lawsuit, the State of Missouri may legitimately inquire whether the Missouri program also has a de facto trustee.  Since Missouri’s preneed financial examinations are not structured to drill for hidden investment costs and inappropriate trust expenditures, the MFT lawsuit seems to be inviting further scrutiny of the trustee by the Division of Finance and the Federal Deposit Insurance Corporation.

*The hidden fees the receiver refers to are 12b-1 fees that the association allowed fund managers to collect off various mutual funds.  Those types of fees are often in addition to basis points fees charged by the fund managers.

In his final report to the court, the Wisconsin Master Trust receiver proposed a new trust agreement that is intended to provide “transparency, accountability, oversight and prudence”.   Similarly, the California Attorney General seeks to provide transparency through express reporting requirements included in the trust agreement proposed to the court presiding over the California Master Trust.  The proposed California Master Trust agreement would provide more program information to the state regulator, funeral homes and trustors/contract purchasers.  Funeral homes were included in the beneficiaries for transparency because the master trust programs often operated in secrecy to participating funeral homes.  Funeral homes participating in the Illinois master trust were not informed of how the trust invested, or that key man insurance was frequently purchased on owners’ lives without their knowledge.  With three large state master trust programs having been forced to provide greater transparency, it is curious to see a state master trust bringing litigation claiming that information concerning its members, investments and agreements are proprietary and confidential.

On May 22nd, the Missouri Funeral Trust filed a lawsuit against the State Board of Embalmers and Funeral Directors and Catholic Holy Family Society seeking an injunction to protect various program documents and information as confidential.  Catholic Holy Family Society is an insurance company that writes preneed insurance policies, and it hired away from the State Board, an auditor that had handled the examination of the Missouri Funeral Trust program.  For 4 years, the Missouri Funeral Trust has been the subject of a preneed financial examination, and the complaint alleges this gave the auditor unfettered access to program information, including strengths and weaknesses, and which funeral homes might be prime targets for a competitor company to ‘steal away’.  The lawsuit was disclosed to Association members and industry attendees to the Association convention, with an explanation that the Missouri Funeral Trust has very deep pockets and can pursue litigation against any competitor that solicits MFT board members.

Curiously, what is not alleged in the complaint is that the defendants misrepresented any information communicated to program members.  The main message communicated by the lawsuit, and by program representatives, is that the program’s executives should be the sole source of information to the member funeral homes.  This rings a little too familiar with what happened in Wisconsin and Illinois.

Two of the country’s largest association ran master trusts now have pending plans of reorganization.  On May 14th, the receiver appointed for the Wisconsin Master Trust filed a Final Report that outlined to a court his proposal for the reorganization of that program.  On May 22nd, a hearing was held in a California on the Attorney General’s proposal to reorganize the master trust established by that state’s funeral directors association.  Both proposals substantially alter the relationships among the funeral directors association, member funeral homes and the master trusts.  Over the next few weeks we will examine the changes made to these master trusts.

With increasing regularity, preneed consumers are downgrading from traditional funerals to cremation services.  To accommodate the consumer, funeral homes often amend the original contract with a downgrade addendum.   An addendum is used to avoid a contract cancellation and a new contract where additional state fees might be required.    However, downgrade addendum can pose certain problems.

For contracts that are paid in full or have trust balances in excess of the adjusted sales price, a trust funded contract will have excess funding.  Most state preneed laws do not contemplate distributions except for performance or cancellation.

State preneed laws that allow a seller to retain sales expense often do so from the initial payments.  Consequently, when a downgrade addendum is offered after the full sales expense has been collected, the trust balance will have a deficit for the ‘excess’ sales expense collected.

Funeral homes frequently allow the assignment of insurance as partial payment towards a trust funded preneed contract, but the manner in which the assignment is made can cause problems for them.  Preneed trustees will not accept an insurance policy for a host of reasons.  Insurance proceeds paid to a trust are not tax free and require individual administration for tax reporting.  Most preneed trusts are also subject to the prudent investor rule, which requires diversification.  Insurance policies do not pay income for the payment of expenses.  Upon the cancellation or lapse of a trust funded contract, applicable law typically contemplates the return of funds (not an insurance policy).  Consequently, most trustees will not accept the insurance policy.

If applicable state law allows the funeral home to be named the policy beneficiary, then there are ways for the funeral home to use a contract addendum where both trust funding and insurance funding are considered.  The goods and services to be purchased with each source of funding should be described separately.   If a trust funded contract is prepared describing all goods and services with the insurance policy as partial payment, the contract will appear to an auditor as underfunded.  The funding reported by the trustee will never reflect the insurance proceeds.   In Missouri, auditors rely upon the trustee report to identify consumers to send inquiry letters.  (Letters are sent to trust accounts that reflect amounts are still due on the preneed contract.)  One funeral director complained to us about this procedure, suggesting that auditors should be able to figure this out.  In response, we suggested that funeral homes can expedite the audit procedure by avoiding that situation.

We advise funeral homes to apply insurance proceeds with a non-guaranteed insurance addendum.  We recommend the insurance addendum be non-guaranteed because there is too high an incidence of the insurance proceeds failing to cover the planned costs of the funeral.  This can be due to policy lapses, family members borrowing against the policy or the policy not keeping track with funeral costs.

The trust funded portion of the contract should only describe those services and merchandise to be paid by the trust.  But, the funeral director has a decision to make about whether the trust funded portion of the contract should be guaranteed.  If the sales price of the trust funded portion is less than the non-declinable services and the casket price, then we would recommend a non-guaranteed contract.

It is common for a funeral home to offer a discount to a preneed contract purchaser when the sales price is to be paid in full at the time of purchase.  However, funeral homes are often inconsistent in how the discount is applied to the preneed contract.  We have seen the discount recorded as a payment credit, a reduction to the aggregate purchase price, as a reduction to the cash advance funds, or as a reduction to the purchase price of the guaranteed goods and services.  Of these approaches, we would recommend the latter.

We recommend against the payment credit approach because it can cause an auditor to mistake the account as being underfunded.   With the payment credit approach, the funeral director will complete the contract using the General Price List to prepare the final contract purchase price and then reduce the outstanding balance owed.   Auditors will typically compare the trust balance to the contract sales price to determine if the contract’s funding is adequate.   In Missouri, the auditors send a letter to each consumer when the trust does not appear to be ‘fully funded’.

When the discount is applied to the aggregate purchase price without reference to either the guaranteed goods and services purchase price or the cash advance items, there can be confusion regarding the proper sales expense charge.  In Missouri, the 10% sales expense can only be charged to the purchase price of the guaranteed items.

Applying the discount to cash advances will reduce the funds meant to cover expenses that the consumer must bear at a future date.   The consumer hasn’t truly saved anything through the discount.

If a discount is to be given, it should be applied solely to the purchase price of guaranteed goods and services.  But, funeral homes must also consider the FTC opinion that non-declinable services cannot be discounted.  (Click here for Opinion 09-1)  Consequently, other itemized goods and services essentially bear the entire discount.

A Kansas City Star article reported on the role of the Missing in Action Project in getting Major Rombauer to his final resting place.  Much of the work of the MIA Project goes unreported, but this story was found noteworthy because Major Rombauer’s cremains had been sitting on a shelf at the crematory for 102 years.   All too often our country’s veterans are denied the final act of respect, and instead of a burial or interment, their cremated remains are never claimed from the funeral home or crematory.   “Abandoned cremains” can pose various legal problems for the funeral home or crematory when their authorization forms do not address the right of sepulcher and when ‘abandonment’ occurs.

The right of sepulcher is a quasi property right that each person has with regard to how his or her remains are to be handled.  We each can make a written designation of the right of sepulcher, or in the absence of such a designation, the right of sepulcher passes to family members.   When cremation is chosen, the right of sepulcher is not competed until the cremains are delivered back to the individual who originally authorized the disposition.   But cremation authorization forms frequently do not address when cremains are abandoned, and how the cremains are to be handled when abandonment occurs.  It is unfortunate, but family disputes often occur over the final disposition of a loved one’s cremains.   Litigation exposures do cause some cremains to sit on the shelf for years, and after a period of time, to go forgotten.

An Oklahoma funeral director faces serious prison time over the deposit of preneed funds to his business operating account.  The Oklahoma Department of Insurance decided to go to a local prosecutor when a Department audit found the funeral director had routinely failed to deposit consumer funds to the preneed trust required by state law.  The funeral director’s attorney has suggested to news sources that although the funeral director admitted the funds were deposited to the operating account, no funds were missing.  Consumers were getting their funerals, and his client was only guilty of being ‘sloppy’.  But, the Department would have no part of the ‘no harm, no foul’ defense.   The Oklahoma authorities have taken the position that criminal intent is determined by the decision on whether to comply with the deposit requirement, not whether the funeral director has intent to honor the contract.

Missouri and Illinois funeral directors have similar deposit requirements with regard to consumer preneed funds.  So do Missouri cemeteries that sell merchandise and services on a preneed basis.  Prior to the overhaul of Chapter 436 in 2009, the Missouri preneed law was ambiguous regarding the deposit requirements for consumer funds.  Today, Section 436.430 requires consumer funds to be deposited directly to trust within 60 days of receipt by the seller.  The ‘deposit directly to trust’ brought objections from large operators that include finance charges and other fees in the preneed sale, and an accommodation was made by the State Board to allow deposits to a clearing account.  However, Missouri funeral homes that use a clearing account bear the burden of proof that the account is merely an extension of the trust.

Until December 2016, the Missouri funeral director who fails to deposit consumer funds to trust within 60 days of receipt has exposure to class c felony charges.  Subsequent to January 2017, these violations of Chapter 436 will carry a class d felony penalty.  With the 2009 law change, the preneed auditors of the Missouri State Board of Embalmers and Funeral Directors are now on the front line for determining compliance with the trust deposit requirement. While Chapter 436 provides concurrent jurisdiction to the Missouri Attorney General and local prosecutors, the law contemplates the State Board first referring possible prosecution matters to the AG.  As an industry board, the State Board will lean towards giving funeral directors every opportunity to ‘get right with the Lord’, but we are five years into the ‘new’ law and that should be enough time to figure out which deposit book to use.  Restoring consumer confidence requires proactive use of the authorities granted by the Legislature in 2009, including the Oklahoma option.