In prior posts we have documented certain similarities between the old IFDA master trust and the Wisconsin master trust, and our Illinois clients have expressed sympathy for their colleagues to the north. But, key differences exist between the two master trusts, and the recent settlement agreement offered to Wisconsin funeral homes is an indication that the WMT receiver has an appreciation for those differences, and is seeking to avoid the litigation expenses that were ultimately incurred by Illinois funeral homes.

Indecision and missteps by the Illinois Comptroller resulted in competing lawsuits by consumers and multiple groups of funeral homes. The Comptroller compounded the situation further by forcing Merrill Lynch to assume trusteeship over the key man policies it had sold to the IFDA. In contrast, the Wisconsin receiver has adopted a strategy to negotiate settlements with key parties by first forging a settlement with funeral homes. The proposed funeral home settlement is called a Pierringer Agreement, and is intended to pave the way for negotiated settlements when multiple defendants with varying degrees of fault. As reported by the Milwaukee Journal Sentinel, certain parties may want to resolve their liability exposures through a settlement, but are unwilling to so long as individual funeral homes could subsequently bring their own lawsuit.

Consequently, the receiver is seeking to gain leverage with those key parties by forcing the hand of the individual funeral home. As the reference article explains, it is a necessary strategy to breaking the settlement logjam.

 

 The Nebraska Department of Insurance released its legislative proposal for revising the preneed law that has been in effect since 1987. Written during a time when interest rates were high, the Nebraska law imposed a CPI accrual but allowed income in excess of that accrual to be distributed to the preneed seller. The law also required an annual report of the trust (as opposed to individual contracts). What evolved was a reporting system that was dependent upon the trustee’s tax accounting. In an era when a trustee invested exclusively in bonds, and held them to maturity, the trust’s tax cost basis would track trust deposits and accrued income fairly closely. But, the Nebraska system doesn’t work so well in an environment that requires investment diversification and the risk of value fluctuations. Nor does the system work for the trust that remained in fixed income investments through the 2008 mortgage crisis. In recent years, fixed income returns have not kept pace with the CPI requirement. The reluctance to diversify turns the seller into a Fed watcher. Any time Mr. Bernanke hints at an increase in the interest rates, the seller’s bond portfolio value lurches lower. Yet, the NE law allows the seller to be paid trust deposits plus accrued CPI on the performance of the preneed contracts. So, the DOI is seeking to introduce market value to the Nebraska preneed industry

 My son, the 5th year senior, lamented to my wife and I a few months ago about a reading assignment given in an engineering lab.  He was frustrated because the assignment would take all weekend, and the Jayhawks would be at Allen Fieldhouse that Saturday.  I questioned him whether the professor had given the assignment as punishment to the class.  No, he replied, the professor always assigns long reading assignments.  Okay, so what is the problem? We’re going to be quizzed this time.  

 The members of the Missouri State Board of Embalmers and Funeral Directors (and the industry) were given a long reading assignment Thursday night: the agenda for the Board meeting next Tuesday and Wednesday.  The agenda is over 200 pages (without any pictures)!   

A weekend isn’t sufficient time to prepare for a discussion on renewal reports and legislative proposals.   Personally, I am going to audit this class and weigh my options.   

 The Missouri State Board of Embalmers and Funeral Directors will meet in a few weeks, and the topic of fees may be on the agenda. The staff broached the fees topic at the spring meeting, but the matter was tabled for subsequent discussion. Fees and the preneed examination process go hand in hand, and so we anticipate the industry will press the staff for an explanation about the exam budget. The industry desire will be to cut the $36 per contract fee, but the staff will likely counter that until every seller has been examined, the on-site audits (The On-Site Audit: getting to know your business) will dictate against any reduction in the contract fee. While the on-site audit may fulfill an important function in communicating record keeping issues to licensees, can the document production request and the desk audit process be revised to expedite the on-site audit? Could the seller’s renewal report also be revised to better serve the examination process while reducing the record keeping required of licensees and trustees?

Under Missouri’s prior law, the seller’s renewal report served primarily to compute the $2 per contract fee. While the renewal report continues to serve that function (albeit at a much higher rate), the report also provides individual contract data (ostensibly as base data for financial examinations). The reporting period for this data is tied to the Division of Professional Registration’s licensing schedules and fiscal year. In doing so, the Division only affords the industry 60 days in which to ‘close its books’ and update individual contract data. When one peruses the list of State Board discipline actions, there are a significant number of suspensions for late seller filings. Missouri having the shortest data turnaround window among the Midwest states must play a role.

In contrast, most states seek contract data on a calendar year because that period coincides with tax reporting and standard trust reporting. Trustees also produce tax ledger statements that are calendar year based. Utilizing existing accounting records not only reduces the trustee’s record keeping, it could help standardize Missouri’s examination process (one element in reducing costs). One must also question the need for fiscal year data when the seller has to provide a current contract report for the document production request.

The Division’s single document approach to the seller renewal is also unnecessarily burdensome to the industry. While the seller and the trustee need to collaborate with regard to individual account administration, the trustee will be the sole source of certain data the Division seeks. The process could be simplified if the trustee were allowed to certify the aggregate trust information by a separate form that contemplates the calendar year trust reports. Banks are notoriously slow, and the single form format puts the licensee at risk due to no fault of his own.

As cemeteries struggle with harsh economic conditions, regulators are bound to look at their ‘problem cemeteries’ and weigh whether legal proceedings are necessary to preserve the care funds mandated by state law. To the extent such proceedings are premised in part on how capital gains are defined and whether distributions from capital gains are an invasion of principal, cemeteries will appropriately ask why they are responsible for the administration performed by the care fund trustee. Eighteen months ago, legal proceedings brought by regulators against a Kansas cemetery prompted our post titled: Perpetual Care and Capital Gains: the government’s rainy day fund? This author provided expert testimony in those proceedings, and a decision was recently issued in the matter by the Kansas Court of Appeals. While the decision will be hailed by the cemetery as a win, the ruling leaves several trust administration issues unresolved, including whether a new law can be applied retroactively to existing care fund trusts.

In response to the howling cemetery operator, the regulator’s pat, but unconvincing, answer is that care fund laws provide me jurisdiction over you, not the trustee. Pulling the cemetery’s license (or cemetery charter in Kansas) is the regulator’s greatest weapon. But, as the Kansas decisions reflect, courts are reluctant to ‘close down’ a cemetery over trust administrative issues. Who will bury the dead if we pad lock the gate? In any event, isn’t the distribution of capital gains consistent with the legislative intent of the cemetery care fund laws? (Ultimately, the goal of the care fund requirement is to keep these ‘private’ cemeteries off the ‘public charge’. At least the Kansas Attorney General opined to issues once or twice that support such a conclusion )

While the cemetery regulators may not have jurisdiction over the trustee, the laws often provide jurisdiction over the trust instrument to which the trustee is a party. To the extent the law affords the regulator the authority to issue orders to the trustee to cease distributions, trust agreements can be required to expressly reflect such authority. If trust administration fails to comply with applicable law, then the regulator has an avenue to ‘turn off the tap’ until the dispute can be resolved or litigated.

 

For state death care regulators, SCI has long been the 800 pound gorilla. Most state death care laws are decades old because the industry’s rank and file operators generally oppose change. To address problem operators (or problem business practices), the regulator employed ‘creative’ interpretations of the law (or regulation) to support broader enforcement powers. That strategy often worked with small operators who could not afford the legal expense required to challenge the regulator’s statutory authority. But when the strategy targeted a business practice, the regulator ran the risk of poking the gorilla. The gorilla’s response would often depend on how intrusive the regulator’s goal was to a preneed system that served multiple states. Historically, the dance between the regulator and the gorilla was more of a private affair. That dance changed in recent years because of regulators’ need for legislative reform. As witnessed in Missouri and Kansas, SCI blocked the first attempts to pass cemetery reform bills. With cemetery legislation looming in Wisconsin, Nebraska and Kansas, regulators (and interested parties) need to plan their dance card for a gorilla that is gaining substantial girth (and a vested interest in cemetery laws).

I stand corrected.

A representative of the Michigan Funeral Directors Association advises that their request for proposal for a new investment advisor for the master trust has resulted in the selection of a firm that will not only assume a true fiduciary relationship to funeral directors and consumers, but that will also guide the Association towards a target date investment strategy. Such an investment strategy would represent a true demarcation from the approach I was so critical of in a March post about the Michigan RFP.

Too often, the fiduciary’s approach to preneed investment has been to offer three investment options to the funeral director. The fiduciary may even allow the funeral director to choose an asset allocation among the investment options. Little regard is given to the experience and sophistication the funeral director possesses with regard to financial and investment considerations. While Michigan law imposes a separate investment standard on non-guaranteed contracts, that is not the case in most states. Consequently, the two types of contracts are typically pooled in the same trust, and invested similarly. This presents a problem for the funeral directors that either take chances with the market or are ultra conservative. Another flawed investment approach is to allow income reporting to be the exclusive consideration.

Corporate fiduciaries have struggled with the delegation of investment responsibilities of the preneed trust. The uniform trust code contemplates the delegation of the investment responsibilities, and may even require such when the fiduciary lacks the expertise to properly invest the trust. But, it is virtually impossible to transfer the liability of that delegation. Applicable statutes contemplate notice and consent of the trust beneficiaries. The investment risk lies with the consumer who has purchased a non-guaranteed contract. With guaranteed contracts, the investment risk is assumed primarily by the funeral director. However, that risk is shifted to the consumer if the contract is ‘re-written’ when the purchaser’s survivors select a different arrangement at the time of need. The investment risk is also transferred when the funeral home goes out of business and the preneed contracts are not assumed by a successor entity.

Depending upon the factors incorporated by the investment strategy, the target date plan can provide a better model for the death care industry.

For many Illinois funeral homes, April 15th served as a bitter reminder of Merrill Lynch and the financial losses suffered by the IFDA master trust. The final Merrill Lynch settlements (approximately $41 million) were received in 2012, and taxes had to be paid on those funds this past tax day. Funeral directors have questioned how those settlement payments could be taxed as income after the losses suffered when Merrill Lynch (as trustee) terminated the key man policies sold to the trust by a Merrill Lynch investment broker. After all, the aggregate settlement payments ($59 million) did not come close to covering the write downs taken by the trust ($76 million). But, Merrill Lynch took the position that a write down in a funeral home’s trust value for policy surrenders did not represent an investment loss. To compound the situation, Merrill Lynch filed a final Form 1041qft for each funeral home that transferred out of the master trust and treated the trust as terminated.

The question is whether Merrill Lynch could have characterized the value write downs so as to afford the funeral homes a capital loss carry over that could be applied to the settlement payments and future income. If one assumes the lowest Form 1041qft tax rate of 15%, Merrill Lynch could have saved the IFDA master trust participants income taxes of approximately $11.5 million.

With Merrill Lynch now out of the IFDA picture, funeral homes may want to turn to the IFDA’s new trustee for assistance. If the write downs can be properly characterized as losses that can be used as capital loss carryovers, it may be worthwhile to have those ‘final’ 1041QFT returns amended. As fiduciary of the Wisconsin Master Trust, the IFDA trustee may have already contemplated this issue.
 

Here is proof that readership of newspapers is going down.

The Milwaukee Journal Sentinel called a few weeks back about a Wisconsin legislative bill that sought investment freedom for cemetery trust funds.  With the legislative battle that was waged a year ago in Wisconsin, we had expected the bill might represent a renewed effort to allow common ownership of funeral homes and cemeteries.  But instead, five Wisconsin legislators are sponsoring a proposal that would allow Wisconsin cemeteries to bypass fiduciary institutions and allow their trust funds to be administered by broker-dealers. The lead sponsor commented to the newspaper reporter that “It’s really not a big deal. Cemeteries are already investing with these folks.”  The sponsor indicated that he introduced the bill at the request of a stockbroker who had been investing a cemetery’s funds for years without knowing he had been doing so illegally.      

Death care operators should take note that the duties of the “fund manager” differ as between a broker-dealer and a registered investment advisor (RIA).  As explained in the SEC’s 2011 “Study on Investment Advisers and Broker-Dealers”, while the RIA has a fiduciary duty to know his client, the broker-dealer does not have such a relationship unless the circumstances dictate otherwise.  The broker-dealer is only required to make recommendations consistent with the customer’s interests.  Ask any RIA if the difference is important.  But, the Wisconsin cemetery bill underscores the duty that is missing from both RIAs and broker-dealers: the duty to comply with the laws applicable to the client’s trust fund. 

The OCC made this duty known to federally chartered preneed trustees more than 10 years ago.  But, a broker-dealer has no duty to stay up on Wisconsin’s Chapter 157.  It makes you wonder whether the sponsors of Assembly Bill 79 were staying up with the troubles of the Wisconsin Master Trust. 

But then again, that trust did have a fiduciary.    

  

 

More than one funeral director has expressed the opinion that the State Board should never have been given rule making authority. We’ll never know, but if the State Board had rulemaking authority 22 years ago, it could have implemented rules to help enforce NPS’ 1990 settlement agreement, and thereby avoided that company’s collapse. But equally important, rule making authority provides the State Board the means to clarify the ambiguities and gaps that exist in Senate Bill. No 1. This is as much to assist the preneed seller who has a business practice that does not fall neatly within the law as it does the State Board attempting to address how that practice should be regulated.

But, Missouri’s first attempt to pass a ‘conventional’ preneed regulation has been a trying exercise for the State Board, its staff and the industry, with mutual frustrations getting the better of everyone. All concerned may have been spoiled by the level of cooperation exhibited when emergency regulations were needed to keep Missouri’s preneed industry operating. Had it not been for those emergency regulations, Missouri’s preneed industry would have come to a screeching halt for months.

Following the passage of the emergency rules, the State Board staff recommended that the industry’s other SB1 complaints be tabled to provide the financial examination process the time required for Division personnel to ‘get their arms around the issues". That made perfect sense to this author, that is until the insurance assignment became the focal point for the Board’s first regulation.

The political realities are that the State of Missouri needs revenues, and the excess insurance proceeds paid to funeral homes should be paid to the State pursuant to RSMo 208.010.7(4) before refunded to the families of assistance recipients. If funeral homes use the spend down provisions to their benefit when meeting with families, then they should also have a duty to comply with Chapter 208. But, the problem has been that families were allowed to exclude insurance policies for asset testing without a preneed contract, and the drafters of SB1 were focused on NPS and the sale of preneed contracts.

SB1 has flaws, and the Division once acknowledged that corrective legislation would eventually be needed. Our question is whether the Board’s first regulation is indication that the State now has a double standard when it comes to preneed regulations and the need for corrective legislation: a restrictive interpretation of SB1 for the industry and a liberal interpretation for itself?

Like SB1, the Board’s first regulation proposal was forced by the State, and has its own flaws. The proposal is too broad in attempting to define all insurance assignments and beneficiary designations as the consideration that triggers SB1. The proposal also extends the preneed contract fee without an explanation of the examination procedures needed for the transaction. Then to buttress the position that the regulation binds all outstanding insurance assignments, the State relies upon a confidential legal memorandum as having put the industry on notice. If the industry does not find the State’s rationale credible, many funeral homes may refuse to comply. We find it frustrating that the State could accomplish most of what it wants without sacrificing credibility. That credibility will be important to getting funeral homes to embrace the future changes required for compliance with SB1. It remains to be seen whether the State will be flexible with the industry in achieving their mutual goals.