The “R” word is back again. We’re only three years removed from the housing bubble burst, but a sense of normalcy seemed to be returning to the death care industry. It wasn’t necessarily a return to the old ways, not with the increase in cremations and regulations. But, many operators were coming to grips with the changes that needed to be made. This past week’s events suggest the nation’s economy has entered another turbulent period that could last several years.

The debt-ceiling crisis, cuts to government spending, and foreign debt problems impacted US government bonds, foreign bond markets and the stock market. That’s bad news for insurance companies, preneed trusts and perpetual care trusts. Regardless of what type of funding a death care operator uses, the two-year economic forecast has to be concerning. The costs to servicing a guaranteed contract will likely outpace the funding growth.

Insurance companies will attempt to adjust through premium rate changes. But, can the consumer afford the premiums? As reported by the Wall Street Journal a year ago, consumers are finding they cannot afford the multiple pay policy, and if they have to cancel, the cash surrender value is a fraction of the amount paid.

We panned this article when published because it tried to characterize preneed as an investment, and for the elder attorney’s naïveté. However, the concluding recommendation has merit. A final expense trust provides both the consumer and death care operator a funding alternative that can meet their respective needs: affordability, flexibility, protections and higher cancellation refunds. But, it is not practical advice to tell the consumer to start up his/her own trust. Rather, this is an opportunity for death care operators to offer a product matched to the times.
 

The Saturday edition of the Kansas City Star includes a section titled “Faith” that is devoted to the issues of religion. A few weeks ago, Star reporter Helen Gray wrote two different Faith articles regarding local funeral trends: cremation and one funeral operation’s focus on working closer with churches.

The cremation article offered the observations from both clergy and funeral directors. The clergy acknowledged that cost and a growing social acceptance have contributed to the rise in cremations (which stands in stark contrast to the comment of one corporate spokesman reporting second-hand how nothing has really changed). But, the comments suggest that some clergy (like many funeral directors) are still simply reacting to cremations. (Another Kansas City Star contributor, Bill Tammeus, wrote a piece titled “Cremains of the Day” that touches on the problems clergy have cremation.)

The other article focused on how one local funeral operation has adopted a very proactive approach to working with area churches. By operating without a “home”, this funeral operation has lower overhead, and can provide lower costing services to churches. The operation’s success would seem to be putting more emphasis on working in tandem with the minister, and less emphasis on directing the funeral.
 

As reported by the Memorial Business Journal*, the Illinois Funeral Directors Association has taken back the helm. For the past three years, the IFDA has been a floundering ship in risk of sinking. The master trust that paved the Association’s growth, has been threatening to bring it down. The IFDA took a crucial step to righting the ship when it relieved the ‘Calvert Group’ as plaintiff in the master trust lawsuits. IFDA leadership still faces several challenges to the Association’s survival, but taking charge of the master trust litigation was crucial. Now they must chart a course for resolution of the litigation. IFDA members will be asked to temper their expectations, and that may require an understanding of the master trust and how it crashed.

The Association built a massive master trust through the participation of hundreds of funeral homes from Chicago to Cairo. The program advisors sought to provide what members wanted: simple contract forms, contract data inputting, no risk investments, a consistent return, immediate payouts, and no tax statements. Those advisors also sought to provide the Association a growing source of revenue to support lobbying efforts, educational programs, conventions and even a museum. While all may have seemed good for twenty years, IFDA Services, as the trustee, was playing by its own set of rules. The architect who designed the master trust exploited a provision in the Illinois law that was intended to allow the small operator to avoid the costs of a corporate fiduciary.

In the absence of institutional oversight, the program was more akin to a defined benefits plan or a fraternal insurance company than a trust. The program architect ignored the fundamental fiduciary duties of the preneed trustee, and treated consumers’ payments as though they belonged to the Association. Having crossed that threshold, the program began purchasing an insurance product that would never have been a suitable investment for a preneed trust. The program has been flawed for many years, with many individuals contributing to its problems.

Many IFDA members are measuring their damages by the “values” reported by IFDA Service before the crash, and will not want to settle for less. But, the reason the Comptroller pulled the plug on the program was because, among other things, the master trust promised more than it could deliver.

 *Reprinted with permission from the July 21, 2011 issue of the Memorial Business Journal. To subscribe please call 609-815-8145.
 

Blame it on the economy, or on ‘unfavorable secular trends’, but as cremation rates continue to rise, operators need to consider their General Price List and their non-declinable basic service fee. In many parts of the country, competition has driven the price of the direct cremation far below the charge that the funeral home requires for its basic professional services. It is the FTC’s position that the death care operator cannot discount its basic professional services fee, and this causes operators to question whether a cremation service can be priced below the basic professional services fee.

The FTC staff has issued informal opinions that except direct cremations from the “no discount rule”. But, operators enter into a gray area when they create cremation packages that offer more than a direct cremation, but cost less than the basic professional services fee.

In response to an inquiry about home funerals, the FTC staff opened the door to alternative basic professional services fees. The staff indicated that it would not object to a reduction in the basic services fees for home funerals if the reduction is commensurate with the limited use of the provider’s facilities and services. For those funeral homes that do not own a crematory, their role in the cremation is similar to that when assisting with a home funeral. Consequently, the FTC opinion would seem to allow these operators to offer an alternative basic fee for cremations.

Cremation societies often set the lowest cremation price in a community because they do not have the overhead of a funeral home. But when the family wants more than a direct cremation, the comparison of cremation packages becomes more difficult. Operations that compete for cremations should consider expanding their GPL to explain the various services that are included in the cremation packages.
 

Not that close, even from the 30,000-foot view.

That’s our assessment of the Morningstar analysis of preneed and its impact on the death care industry. In “Dark Clouds for the Death-Care Industry”, a stock analyst attempted to explain the preneed transaction, and then provide an assessment of the impact of preneed on the profitability of the death care industry. Such attempts to generalize preneed are often misleading, particularly by an outsider looking in.

While the analyst raises a number of issues regarding preneed, only one can be described as generally accurate: there is a growing reliance on preneed sales. But then, operators in the smaller or rural communities may disagree because they do not face the competitive pressures that drive preneed sales. For the majority of the industry’s operators, competition has made preneed a necessity.

The article suggests that all preneed sales end up in trusts, and that the trust exposes the operator to investment risks. While this generalization has some merit, it completely ignores insurance funded preneed, and how those sales provide a background to assess the analyst’s preneed conclusions.

A majority of the states have preneed funeral laws that impose trusting requirements of 90% or more. The costs associated with a preneed program force larger operators in the 100% states to use insurance funding for the commission that will pay salesmen. The complaint currently heard from these operators is that the return on their insurance proceeds is not keeping pace with inflation.

The analyst states he would feel more comfortable if the industry turned to insurance companies for underwriting of the industry’s massive trust portfolios. Excuse me? The main problem with preneed trusts is that they are saddled with expenses, and are often ‘parked’ in fixed income investments. So, Wall Street’s solution to preneed would be to add a layer of expense through underwriting? Ignoring the state law issues, aren’t you suggesting to the operator that he should sacrifice the upside of his trust for the stability of a lower, more consistent return? How would that recommendation achieve the growth that you state is lacking for this industry?

The analyst also states that the industry must rely on preneed because of the lack of overall deaths in the marketplace. Perhaps the analyst meant to say there is too much competition for the current death rates in our communities. If so, then yes, preneed is becoming as important as heritage in maintaining (or growing) the operator’s market share. If the investment community believes preneed is bad for us, how would Wall Street propose funeral homes and cemeteries respond to competition in the market place?

Wall Street concerns over preneed are driven in part by misconceptions about the operator’s costs, and his exposures to trust funding liabilities. The analyst fails to make a distinction between the cost to perform a preneed contact and the prices listed on a general price list. The amount paid out of a trust when a preneed contract may not equal the current at need prices, but the trust proceeds do generally exceed the costs of the services and merchandise. Depending on the age of the contract, and the state’s trusting requirements, the older contracts may not be very ‘profitable’, but there is a profit, just not as profitable as the comparable at-need service.

The analyst also expresses concern the operator’s liability to fund the trust when the investment markets decline as they did in 2009. What state law requires that? Operators are not required to make ‘capital injections’ into their preneed trusts for investment declines. Such conditions may affect their authority to make income withdrawals, but not to require additional contributions.

Wall Street would prefer the death care industry to return to the day where at-need revenues constitute the base of operations. Most death care operators would share that desire, but most know better. Contrary to the analyst’s conclusion, operators are finding that it is the at-need service that is exposed to downturns in discretionary spending. Tight times make it easier for the consumer to choose cremation. If the preneed contract is paid in full, the family isn’t forced to come out of pocket to pay for the traditional service.

In conclusion, I have to concede that the analyst is somewhat correct about preneed exposing the operator to investment risks. Preneed has become a business reality, requiring many operators to make a decision between insurance or trust. Should the operator take the lower, but safer, rate of return of the insurance policy, or keep the upside of the trust (and its risks)?

Large funeral operators in 100% trusting states don’t have much choice but to use insurance.  For the funeral operator who wants growth and control over the direction of the preneed fund, then there is little choice but to assume the investment market risks that accompany the preneed trust. Cemeteries have no choice but to use the trust, and assume its investment risks. Cemetery preneed can be distinguished from that sold by funeral homes in that some merchandise (and services) is delivered prior to death, precluding the use of insurance.  

A few months ago, a stock analyst issued a critique warning against investment in the industry’s public companies. A few weeks later, the critique got a second wind when chat pages and social media forums picked up on the critique’s conclusion, and circulated the article as proof that certain trends will ‘haunt’ all funeral homes and cemeteries for years to come. Several weeks later, the critique’s attempt to assess or explain the industry’s key issues continues to haunt me. If a professional who makes his living from investment assessments has difficulty grasping and explaining the intricacies of the death care industry, consider the difficulties our regulators and legislators may have understanding the business.

The critique identified “the” three issues impacting the industry’s revenues and profitability: cremation, preneed and longer life expectancies. This post will focus on cremation.

The analyst opens with the statement that ‘several unfavorable secular trends’ are hampering long-term growth and profitability in the death care industry. But, the critique concludes with sticking the “unfavorable secular trend” label solely on cremation. There is no doubt that cremation is turning the industry on its head, but is the “secular trend” label important? It is when you view the history of the business, and need to convey the depth of the cremation issue, and that it will continue to grow.

The American way of death was shaped by the Christian funeral and burial. Theology professor Thomas Long has written several insightful books and articles regarding the Christian funeral and the role of the body. Another excellent work is Paul Irion’s “The Funeral: Vestige or Value?” The growth of death care business can be traced to the fact funeral homes profited by establishing a good relationship with the local church. That fundamental relationship served the funeral home well for several generations. But as our society became more pluralistic and secular, the acceptance of cremation grew.

For theologians, cremation represents a challenge to long standing beliefs about the funeral ritual. But, the emerging message to clergy is one of education and adaptation. As a follow up to his seminal work on the funeral ritual, Paul Irion wrote a book simply titled “Cremation”. This blog has previously discussed this issue, and one form of adaptation by churches: the columbarium.

For the funeral director, a church’s shift to embrace cremation sends a mixed message. The families from these churches view the funeral as having value as a ritual, but a ritual that does not require the purchase of a casket. If the funeral home does not own a crematory, the director will have to compliment the church’s pastoral care, or risk losing the church’s business altogether.

Operators must also market to a public that has become more secular, and view the funeral home as providing a utilitarian service. As the analyst alluded to, once the body is disposed of, all other services are ‘auxiliary’ in nature. The secular public is more likely to purchase a cremation, and forego any type of memorial service.

While cremation has taken away casket sales and cut into the purchase of services, is the critique accurate in its warnings about the death care industry? Keep in mind that the analyst was assessing the industry for profitability and growth, and that growth is difficult for a mature industry to achieve. The death care business has all the characteristics of a mature industry: limited or declining markets, intense competition, and evolving consumer demands. Individual companies may be able to achieve growth, but the industry as a whole may not until the Baby Boomer generation ages another 10 years.

Some mature industries do wither and eventually die away. But in contrast to industries that produce a product with a definitive life cycle, death care is based on a service that will always be needed. Funeral homes may have been guilty of having allocated too much of their profit to the sale of a casket and too little to their services. But, they have the ability to adapt their pricing strategies. For the small operator who cannot afford a crematory, alkaline hydrolysis may provide a less expensive investment. And, there is the green burial alternative to explore.

Next: Dark Clouds and Preneed

Preneed scandals in Illinois, Missouri, Texas, and California have state regulators moving to implement new audit procedures. But with new laws passed in the wake of NPS and state master trust problems, the frequency and scope of the future audit could change dramatically.  It is no secret that the scope of the preneed audit in Missouri is work in progress. When asked how the audit was being revised for its licensees, Illinois regulators politely declined to provide their written guidelines. Regulators in Kansas and Nebraska are also evaluating their audit procedures. But, the legal battle being waged in California provides a glimpse of one regulator’s intent to change the scope of the preneed audit.

The Ninth and Tenth Causes of Actions from the California Attorney General’s lawsuit against the California Master Trust allege that defendants either failed to maintain, or to produce, the preneed records required by law and regulation. California Code of Regulations, title 16, Section 1267 sets out those records that must be maintained by the funeral home. The regulation dates back 30 years, and reflects a view of the preneed transaction that is no longer consistent with the view taken by the Attorney General, and with the direction of the audit and lawsuit.

In a nutshell, the regulation asks for records which are intended to confirm whether the preneed payments were deposited to trust. The underlying principal is that the preneed contract represents a sale that the funeral home will book to its GAAP financial records. The regulation defines the funeral home’s cash receipts journal and general ledger as preneed records. The requirements contemplate that the funeral home will book these sales and payments for compliance with income tax reporting. By requiring the financial books and records, the preneed auditor can then track a consumer payment from funeral home receipt to the preneed trust. While the funeral director might not fear the preneed regulator, he is not likely to hide the income from Uncle Sam.

However, the California litigation is not about money that didn’t make it to trust, it is about the administration of the trust assets. In attempting to investigate the administration of the trust, the preneed auditor went beyond what the regulation calls for. The best evidence of the expanding scope of the audit is the defendants’ response letter to the Cemetery and Funeral Bureau audit findings. The response letter indicates that one funeral home was cited for failing to have the following records:

• All correspondence with the trust administrator
• Copies of contracts that provide services to the trust
• Records of administrative costs
• Records of administrative costs allocated among the trustee and its vendors
• The portfolio of trust investments

When questioned about its authority for the requests, the Bureau reply stated that the trustee failed to make available “complete financial records for all preneed contracts and arrangements”. This answer fails to clarify what trust and financial records the funeral home must maintain on its premises.

What seems to come through from the California litigation is that original approach to the audit, ensuring the funds made it to trust, and leaving trust oversight to the independent CPA and an opinion, failed the California consumer. But, could the Bureau have better protected the consumer if the financial records have been kept at the individual funeral homes? (No, not without additional guidelines on the management of master trusts and pooled accounts.) And even if such regulations existed, it would be expecting too much from the auditor whose duties entail visits to hundreds of the funeral homes.

While the field auditor is an important element of the preneed compliance program, the program has to include the administration of preneed trust. Does this mean the funeral director must maintain correspondence and records related to the trust’s administration? The best course of action would be to establish a file for all trust related documents and correspondence. With the increase of preneed portability and the sale of non-guaranteed contracts, the funeral director’s reliance on the ‘guaranteed contract defense’ becomes more tenuous. In a limited sense, the funeral director is becoming a fund manager on behalf of the consumer.
 

As reported previously in the blog, the State of Nebraska began to implement a preneed contract database in 2010 when master trusts were requested to provide individual contract data in an electronic format. The request was expanded to all preneed sellers in 2011.

Kansas Secretary of State sought legislation in 2010 for the authority to seek individual preneed data from its cemeteries selling preneed. While the KSOS initial effort fell short, a second effort passed the legislature a few weeks ago. Under this new bill, cemeteries will be required to trust preneed sales at 50% of the sales price and to report those sales (together with deposits and distributions) on a quarterly basis.

Illinois has now joined the preneed database club with an amendment made to SB0675. The bill will require preneed contracts to be entered into a database maintained by the Comptroller within 45days of the contract date.

As opposed to the paper report of individual contracts, the preneed database provides the regulator more flexibility in reviewing information and creating contract listings from which to begin audits and examinations at the funeral home or cemetery.
 

The Missouri State Board of Embalmers and Funeral Directors staff has some new faces, and in contrast to most rookies, these newcomers are playing pivotal roles in developing examination procedures for the state’s preneed funeral sellers. The Division of Professional Registration chose personnel with prior auditing experience, but as these ‘rookies’ are learning, there is little in the way of guidelines for the examination of trust funded preneed. Missouri’s preneed heritage only makes their task more difficult.

With one of the nation’s more generous trusting requirements, Missouri is dominated by preneed trusts. Until SB1’s passage in 2009, the State Board lacked rulemaking authority to address the numerous gaps and ambiguities in Chapter 436. Chapter 436 also governed the sale of vaults and burial services, which brought cemeteries into the mix. Allow an industry to operate 25 years without examinations or rules and you get a hodge podge of seller programs, each operating differently from the next guy.

Like Forest Gump’s box of chocolates, the preneed examiner may experience a surprise with each seller he/she visits. While these surprises may not necessarily constitute violations of Chapter 436, they can be challenging when seeking a certain continuity from seller to seller. It is that continuity that will help define the examination procedures to use with the preneed trusts established prior to SB1.

As a consequence, Missouri’s preneed examination procedures remain a work in progress. The initial exams will probably take longer, with the examiners comparing notes and revising the draft procedures with each examination. For the time being, those procedures will focus on whether preneed sellers and providers are complying with new preneed contract and licensing requirements, and with the handling of that the preneed payments are being made to the proper funding agent. One of the procedures to be tested by the examiners will be a consumer letter.

As a part of the final stages of the preneed seller exam, the State Board staff will generate a consumer letter with information from the annual report filed by the seller. The letter will go to each consumer who is making payments on a contract, or who has lapsed in making payments. A sampling (5%) of the seller’s paid in full contracts will also receive the letter. The letter will set out the consumer’s contract number, the sales price and payment balance (as reported by the seller), and the request that the consumer contact the examiner only if the consumer’s records conflict with that data.

As reported by the blog in February, Illinois also has a consumer statement requirement, but it differs from Missouri in that the preneed fiduciary must send out the statement, and provide information about expenses and the trust ‘inventory’.

Funeral directors are fearful that such consumer notices will cause confusion, and lead consumers to believe the funeral home is in trouble. While problems may be encountered, the consumer notice is one of the few procedures available for detecting the small percentage of funeral directors who pocket the consumer’s payments. But if handled correctly, the statement could be used to help to maintain consumer confidence in the funeral home.
 

Missouri’s preneed regulator, the State Board of Embalmers and Funeral Directors, will meet June 2nd to continue its discussion of agenda for the upcoming legislative session. Due to the lead time required to formulate legislation, the State Board is forced to begin discussions before its 2011 legislative agenda (SB325) even becomes law on August 28th. With the examination process having only begun this past January, the State Board does not even have the basis to evaluate crucial provisions of Senate Bill No. 1. Accordingly, the State Board faces decisions about what its legislative goals should be for the next year.

For the June 2nd meeting (and its prior May 18th meeting), the State Board staff went back to the various legislative proposals made during the summer of 2010 as a starting point. The temptation of Board may be to go through those proposals and evaluate each one on its merits. But the better approach would be to evaluate each proposal in terms of need and consistency with the legislative intent for SB1.

For example, page 9 of the June 2nd agenda includes changes intended to take preneed trusting to 100%. The proposal was discussed on May 18th, put up for a vote, and then withdrawn for further discussion on June 2nd. While it would be worthwhile to have a discussion on the merits of the proposal (including how 100% trusting would benefit both the consumer and the industry), the more important questions are whether the proposal is needed, and whether it is consistent with the legislative intent of SB1.