The reversal of the Heffner decision generated a wide range of comments, but those made by Wilson Beebe resonated most with our initial review of the decision.  The lower court decision was based on a challenge that the Pennsylvania Funeral Law was unconstitutional on its face.   A law can also be challenged as unconstitutional because of the manner in which it is applied.  The “facial” challenge of a law has far greater consequence because if successful, the entire law is invalidated.   The Supreme Court has expressed concerns how the facial challenge might be used to undermine the legislative process, and accordingly, the challenging party is held to a higher standard of proof:  To succeed in a typical facial attack, [the respondent] would have to establish “that no set of circumstances exists under which [the statute] would be valid”, United States v. Salerno, 481 U.S. 739, 745 (1987).  Put another way, the challenge will fail if the law serves a single legitimate purpose.   The higher standard of proof is to avoid the courts being used to erase a law that the aggrieved could not otherwise change through the legislative process.

As witnessed in Pennsylvania and Wisconsin, competing economic interests are the cause for most death care legislation never advancing out of its assigned committee.   The competing interests need not be as large and divisive as common property ownership and preneed solicitation.  On its face, the bill recently introduced for the Missouri Funeral Directors and Embalmers Association might seem non-controversial.  But, SB883 steps on the toes of large preneed sellers and preneed insurance carriers.   One section of the bill would reduce the window for trust deposits from 60 days to 30 days (requiring sellers to make deposits before internal accounting reconciliations are performed).  Another section would impose preneed contract requirements on insurance assignments that insurance companies are challenging as being outside the current law.  Not looking to take sides in an internal industry dispute, legislators pull back from such proposals until a consensus is worked out.   And then, regulatory approval may also be required.

While anyone can derail a death care bill, associations closely aligned with their regulator have a definite advantage in getting bills through the legislative process.  As a facial challenge to the entire Pennsylvania Funeral Law, the Heffner decision threatened the foundation of the PFDA, and similarly positioned funeral associations.

Our recent post on similarities of the MyRA and non-guaranteed preneed concluded with references to how criticisms of President Obama’s new retirement account were applicable to preneed.  One such criticism relates to the lack of investment performance, but we will save that issue for a future date.  For this post we want to address the costs associated with implementing and maintaining the MyRA.

Bloomberg News noted in an article that fewer employers maintain a pension plan or 401(k) plan due to their costs.  The report included a quote indicating that research has shown middle and moderate income workers are likely to save for retirement when they can do so with a payroll deduction, and are unlikely to do so when they don’t have that option.   The report goes on to note that even though the MyRA would help avoid most administrative costs associated with formal retirement plans, small business groups have opposed basic savings plans because of costs associated with payroll deduction requirements.  If forced to provide payroll deductions for a voluntary retirement program, employers are fearful the accompanying costs will be wasted when employees do not follow through.

Trust funded preneed programs have many of the same administrative costs of a 401(k) plan.  Plan administrators must track individual purchaser accounts and make periodic allocations of income, expense and value.  With the guaranteed contract, preneed sellers have assumed the risks and rewards of investment performance.  Under many states’ preneed laws, the seller also controls income earned by the trust.  Consequently, the seller has been expected to bear excess costs associated with the trust funded preneed program.  While each preneed trust is a common trust fund for purposes of 12 CFR Part 9, Federal policies have been ‘modified’ to reflect the economic realities of the guaranteed contract. In states where trust income can be distributed prior to performance, the IRS and the OCC have been flexible regarding income, expense and value allocations.  In states where income is required to be accrued, trustees can also take comfort in the seller approving allocation procedures.

But when the price guarantee is eliminated from the preneed contract, the purchaser becomes the primary beneficiary of the arrangement, and assumes the risk and reward of investment performance.  There are fewer (if any) penalties to canceling the arrangement or transferring the funds to different funeral homes.  The purchaser can defer payments when emergencies arise, or make payments whenever convenient.  The arrangement has the portability features that consumers and regulators seek.  And, it comes with the tax benefits of the Qualified Funeral Trust (no messy 1099’s or Grantor statements).  The non-guaranteed preneed contract could be called the purchaser’s “MyPreneedAccount”.

But, the funeral home offering MyPA to consumers cannot collect a purchaser’s payments and hand them over to the Federal government for investment and administration.  Instead, preneed administrations arguably have greater administration duties than with the guaranteed contract.  Instead of a single seller, the trust now has multiple income beneficiaries.  The premise for Federal agencies granting administrative flexibility has changed.   And there is the new ‘voluntary’ nature of the MyPA.  Like the MyRA account holder, the non-guaranteed contract purchaser has less incentive to make payments on the preneed contract.  How should the account’s expenses be paid if purchaser has found payments inconvenient after only paying $25?

We are of the mind that non-guaranteed preneed will be beneficial to consumers that need flexibility in preparing for final expenses, and who want to retain greater controls over the account.  But, those benefits and rights come at a cost.  Locally, state regulators have given early indications that they expect the seller to continue to foot the expense of the non-guaranteed contract.   That position is difficult for this author to reconcile with the realities of the MyPreneedAccount.

Because, that is our Policy.

The death care industry is hearing that more frequently these days.   Last July, an Illinois client was advised by the Department of Healthcare and Family Services that his preneed contract would have to be revised to comply with the Department’s new policy about excess preneed funds.  A few clients in other parts of Illinois began to report the same.  I asked that the clients request a copy of the policy.  The Department did not respond to the funeral directors, and so, my office began to make written requests to the Department.  The Department finally replied after 4 months with a contact number to the Department (that proved to be disconnected).  The Department also provided us contact information to the Illinois Funeral Directors Association (an individual who left the association two years ago).  We continued to press the request to the Department, and finally this week, the Department provided hyperlinks to the policy that has been cited to the funeral directors.

What we wanted to determine from the Department policy was the duty owed with regard to excess trust funds, who owed the duty, and the statutory authority for the policy.  If the Department policy was that the trustee had a duty to determine if excess funds existed, and that such funds must be paid to a specific State office, new fiduciary procedures would have to be implemented, and a decision would have to be made with regard to the expense of the handful of accounts affected.  (The policy would likely be triggered only when a family downgraded from a tradition funeral to a cremation.  Even with non-guaranteed contracts, the family tends to spend the entire trust.)

As support of their position that trust funded preneed contracts must pay excess funds to the state, the Department cited my office to the Policy section addressing insurance funded preneed contracts.  Illinois law was amended to require insurance contracts be transferred to trust when a family wants to exclude the insurance cash value from their assets.  Neither that law, nor the Department Policy, was intended to apply to the trust funded preneed contracts used by our Illinois funeral homes.  The Department has atrust funded burial contract section, but no mention is made of excess preneed funds.

Two years ago, the Missouri Division of Professional Registration took the position that it had been State Board of Embalmers and Funeral Directors policy that insurance beneficiary designations were preneed contracts long before the new law passed.  In support of that position, the Division referenced an internal legal memorandum.  As we have explained in prior posts, this “Policy” is motivated in part by the State needing the ‘preneed contract’ definition so that excess insurance funds must be paid over to the State.  (We pressed this issue in the blog and to the Division because we anticipated that the Division will make similar legal reaches to impose “policy decisions” on preneed trustees.)   Nebraska made such a leap last month.

In an email to preneed sellers, the Nebraska Department of Insurance notified funeral homes of the following policy:

Irrevocable Trusts

The Department has found that some Trustees have allowed Pre-Need Purchasers to cash irrevocable trusts without the Pre-Need Seller’s authorization and/or knowledge. Any pre-need contract cancellation request must come from the Pre-Need Seller (in writing), as outlined in the Pre-Need Burial Sales Act. We are working with these Trustees to help them understand their fiduciary responsibilities and the ramifications of cashing irrevocable trusts. Accurate and timely reporting helps reduce the instance of Trustee errors.

What is troubling about the Nebraska “policy” is that most of the banks that will receive the Department’s attention are not fiduciaries.  Those institutions have issued a depository account in conjunction with a Totten trust arrangement.

So, what does this all have to do with the rulemaking process and due diligence?  Not to pick on the Nebraska Department of Insurance, but their introduction of a short, and insignificant, bill (and then issuing a new Irrevocable Trust policy) helps to underscore that regulators are skewing the formal rulemaking process in favor the more expedient policy position that has a higher probability of being erroneous.

Section 12-1109 of the Nebraska Burial Pre-Need Sales Act states that the Department director shall adopt and promulgate rules and regulations necessary to carry out and enforce the act.  In seeking to substitute the word “may” for “shall”, the statement of intent for LB926 advises that the director has not needed to adopt regulations for any purpose.  Industry members maintaining master preneed trusts take issue with the fact the director implemented substantial changes to the annual report form without using the rulemaking process.   While the Director would be advancing legitimate State interests, adherence to the rulemaking procedures would have afforded the industry the opportunity to raise valid objections.   With regard to the master trust users, the Department lacked statutory authority to introduce a market value element to the annual report.  With regard to individual accounts, the depository accounts do not owe fiduciary duties to the State.

These agencies have made known their reasons for avoiding the rulemaking process.  In response, this author would offer the following in support of the rulemaking process.

The preneed transaction has evolved more in the past 3 years than it had in the thirty years preceding 2010.  Experts are debating the virtues of guaranteed versus non-guaranteed, we have witnessed more than one major preneed insurance company partnering with a trust company to offer new forms of hybrid funding, and death care operators are receiving an increasing number of final expense policies sold independent of their facility.  While change to the preneed transaction is long overdue, the pace of developments exposes ‘regulatory gaps’ in even the newest of preneed reform laws.  Missouri is a case in point.  SB1 is less than five years old, and  the Division must stretch that law to address preneed structures and issues that the legislature did not contemplate.  Some of these preneed developments will benefit both consumers and the industry, and some may not.   The rulemaking process provides a forum to obtain information on the issues.   Policies are made in a closed room where there is a higher probability of error.  When an erroneous policy is struck down as invalid rulemaking, the regulator loses credibility with the industry.

President Obama used his State of the Union address to unveil a new type of retirement account dubbed “MyRA”.  Recognizing that Americans are woefully unprepared for their retirement years, the President believes the MyRA offers individuals a safe option to induce them to begin saving for those golden years.  A CNBC report provides an explanation of how the MyRA would work, but the touted advantages include:

  • the ability to open an account with just $25,
  • the account would be invested in a government securities investment fund used by federal employees,
  •  the principal invested into the account would be guaranteed by the Federal government; and
  • the account is not subject to the high expenses associated with a conventional 401(K) account.

It is no coincidence that death care operators are finding these same Americans unprepared for their funeral and burial expenses.  As an industry, we too must find a way to get families to begin ‘saving’ for their funerals and burials.  Financial analysts are critical of the MyRA as falling short of the ‘solution’ for America’s growing pension crisis, but the account has value as an introduction to “saving”.   As alluded to in the January edition of the American Funeral Director, the non-guaranteed preneed contract has the same potential as the MyRA.   Fewer families can afford to purchase a preneed contract with a single payment, or even with 36 monthly payments.  Preneed insurance companies have acknowledged as much with their partnering with trusts companies.

Some of the criticism leveled at the MyRA is applicable to the preneed contract, and we will explore that in future posts.

Legislation was introduced this week in the Kansas Legislature, and one of the bill’s changes seeks to clarify how cemetery care fund requirements can be computed. We have found this a source of confusion for cemeteries and regulators in many states. Depending upon the type of interment right purchased, the care fund requirement is often a percentage of the purchase price. The confusion is whether the care fund amount is part of the purchase price, or in addition to the purchase price. Assuming a purchase price of $1,000.00 and Kansas’ 15% care fund percentage, the difference is $22.50. Multiple that amount by the number of sales between audits, and an audit report may conclude that a deficiency of thousands of dollars exists. Or, the cemetery has been over funding the care fund at the expense of operating profits.

The Kansas Cemetery Association is seeking to clarify that the care fund requirement can be determined in either fashion. Click here to view the legislation, or here to view the bill’s summary brief.

If a cemetery opts to set out care fund requirements as an amount that is in addition to the purchase price, their sales documents will need to be consistent with that approach.

Now that Doug and the gang have been processed into the Federal prison system, the Special Deputy Receiver should consider negotiating a deal with the National Geographic Channel about dedicating a season of Lockdown to the NPS preneed gang. Instead of that boring medical facility in Louisville, Doug and Brent have been assigned to two of the more notorious Federal prisons: Marion and Leavenworth. Accordingly, the potential for captivating plot lines could be infinite. [In our next episode of Lockdown, Doug meets with Guido and Sonny to explain the fine print on John Gotti’s NPS preneed contract and why their boss was better served with a cremation.] With so many NPS victims, Lockdown would be guaranteed a dedicated following.

The International Cemetery, Cremation and Funeral Association (ICCFA) made an old but persuasive argument to get the IRS to exempt cemetery care trusts from the Medicare tax that will fund ObamaCare.  As discussed in a prior post, the IRS had initially proposed to apply the tax to both cemetery care trusts and preneed trusts.  With the publication of the final rule, the IRS acknowledged similarities of the cemetery care trust and the preneed trust in that each is a collection of many small individual trusts created for consumer protection and held for the benefit of the individual purchasers.  The summary went on to reference input provided by commentators regarding IRC Section 642(i), and an assertion that the cemetery company is the only “beneficiary” of the trust for tax purposes.  In contrast to preneed trusts, the IRS agreed that cemetery care trusts should be excluded because their benefit (income) goes to the cemetery company.  This could seem a radical conclusion to some state regulators, and so we pursued the rationale that the IRS found so persuasive. 

Citing the legislative history of IRC Section 642(i), the ICCFA explained how there are a multitude of interests served by cemetery care trusts: the private interests of lot owners, the business interests of cemetery companies, and the public interests of states and local communities in ensuring that cemeteries do not become government responsibilities.  Our recent experiences are that regulators equate the public interests in a care trust as being those of lot owners, and assume a very conservative interpretation of cemetery laws that impact investment policies, the definition of income and principal, and the amendment or termination of care fund trusts.  But, the IRS was persuaded by the ICCFA’s argument that the public interests are more in line with the business interests of the care trust.  While the ICCFA did not offer citations for their interpretation of “public interests”, a Kansas 1965 court decision cited “public interests” when interpreting the intent of that state’s care fund requirements with regard to deposit requirements and the distribution of income:

The statute, originally enacted in 1901 (Laws 1901, ch. 102, § 5), expressed the public concern in maintaining in a seemly manner places set apart as burial grounds and in preventing the maintenance of privately developed public cemeteries from becoming public charges. Being of a remedial nature it is to be liberally construed to effectuate the purpose for which it was enacted (Van Doren v. Etchen, 112 Kan. 380, 383, 211 Pac. 144).

If state regulators were to factor the ICCFA’s public interests position into their interpretations of cemetery care laws, the industry could witness a shift in attitudes concerning care fund deposits and care trust administration.  While trustees would receive more latitude in making investments and distributing “income”, cemetery operators would be expected to more accountable for care fund deposit requirements.

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.  

 A cemetery operator recently expressed his frustration with the trust officer of his care fund trust.   An examination of the trust had cited the operator for inappropriate distributions from principal with regard to expense payments.  We suggested to the operator that it is very common for trustees to set up care fund accounts with a principal account and an income account.  The income account is often set up to be held in cash equivalents because it is anticipated the account will be distributed frequently.  If the cemetery allows the income account to accumulate and sit in cash, the trustee could be questioned about the duty to make those funds productive.  Some fiduciary institutions have strict guidelines about how long funds can be left ‘idle’.  Accordingly, trustees will transfer the idle income cash to the principal account so that it can be reinvested.   The trustee may then look to the principal account to pay fees when the income account is insufficient.  The regulatory auditor may not have time to look any deeper than the distributions summary of the trust transactions report.   The operator and trustee then need to determine if the income distributions plus principal expense payments exceed income.

 Over the past few years, preneed trust administrators have been wondering whether a Section 685 qualified funeral trust could look to each individual trust’s income and apply the lower tax rates for long term capital gains and qualified dividends.  The issue has taken on more relevance as preneed trusts look to diversify out of fixed income securities.  For trustees that have the administration required for periodic allocations of income by character, the effective tax rate of the QFT would drop significantly as trust returns shift from interest income to dividend and capital gains income.  But, the Form 1041QFT is a short document that provides no guidance on whether the 15% tax rate is the lowest possible rate.  Consequently, I was pleasantly surprised with the IRS’ recent publication of the new Medicare tax regulation.   

The Medicare tax is intended to fund ObamaCare by imposing a 3.8% tax on individuals that are in the higher tax brackets. Everyone was a little surprised when the initial IRS proposal would apply the tax to many types of trusts, including preneed trusts and cemetery care trusts.  Representatives from both the funeral industry and the cemetery industry submitted comments to the IRS.  This author expected the IRS to exclude both types of trusts from Medicare tax because neither pays income to individuals.  The final regulation was published in December, and the IRS took the expected position towards cemetery care funds.  The IRS acknowledged that while care fund contributions are made by individuals when purchasing grave spaces, these trusts should be excluded from the tax on the rationale that the cemetery corporation is the beneficiary of the trust income. 

Qualified Funeral Trusts are trusts where the trustees have taken the IRC Section 685 election to have income taxed to the trust rather than to the individual purchasers.  Unless the Section 685 election is made, Revenue Ruling 87-127 would require the trustee to report income to individual consumers.  Since QFTs do not report income to consumers, we expected the IRS to exclude the QFT from the Medicare tax, and to provide guidelines for Pre-88 trusts that report income to funeral homes and any Post-88 trust that report income to consumers.  Instead, the IRS ignored Pre-88 trusts and Post-88 trusts, and applied the tax to QFTs. 

In applying the Medicare tax to QFTs, the IRS advises that each purchaser’s trust income will determine whether the Medicare tax has to be paid.  For the 2013 tax year, a trust would have to realize taxable income of $11,950 before triggering the Medicare tax.  If a QFT is prepared on a composite basis (where income is allocated monthly by character, and computed by individual purchaser trust accounts), it is inconceivable that any preneed contract should ever incur the Medicare tax.  We assume that composite QFT returns have become the industry norm, but the IRS has previously published comments that suggest a substantial number of QFTs are prepared on the gross basis.  For each such QFT, the Medicare tax will take a significant bite out of the trust.

For the composite QFT preparers, this IRS position follows the same approach that preneed administrators have sought with regard to capital gains and qualified dividends.  Even though income will not be reported to the preneed purchaser, the individual trust’s income should determine whether capital gains and qualified dividends are taxable to the trust.  The logic may be difficult to follow but we welcome that approach.