For more than 20 years, Nebraska preneed sellers have filed an annual report that accounts for the aggregate contributions and distributions from their trust funds. The annual report form also computes the amount of income that must be accrued to the account if the seller elects to withdraw excess income from the trust. In its quest to determine whether preneed trusts are adequately funded, the Department of Insurance has made a request for individual contract data that supports the annual report.

Nebraska’s request for individual contract data reflects a trend developing with other Midwest death care regulators.

Individual contract data reporting was a priority in failed legislation by Kansas regulators.

Missouri’s State Board of Embalmers and Funeral Directors has acknowledged the need to determine whether existing preneed trusts are adequately funded, and that objective requires some detail about what comprises the trusts established under the prior law.

Missouri cemeteries are about to embark on preneed sales under a new law, and regulators have already expressed a need to know about those sales.

While many death care operators may challenge the individual account data request as burdensome or intrusive, operators harmed by NPS or the IFDA insurance debacle, have reason to be providing such information.

The degree an NPS provider suffers ‘damage” by honoring a preneed contract depends on several factors: the age of the contract, the casket, the funeral home’s current atneed prices, to name a few. To challenge that more than the guaranty association payout is needed, the industry must be willing to provide hard facts based on actual contract data. If the active NPS contracts are included in a state’s annual reporting, a basis has been established for a database for tracking the NPS consequence to the industry.

The same is true for Illinois funeral directors seeking to recover for the IFDA asset meltdown. Recovery has to be based on contract data.
 

Forest Hills’ preneed consumers were hoping for news of retribution, but Clayton Smart’s anticipated plea bargain was put on hold. If news reports are accurate, authorities from Tennessee (and perhaps Michigan and Indiana) have their sites on the individual(s) who facilitated the transactions that eventually left preneed trusts and permanent maintenance trusts depleted.

For the past few years, Mr. Smart has sat in jail while authorities built their cases. Until recently, Mr. Smart had not even employed an attorney. In what may be tipping his hand, Smart’s attorney now suggests his client has paid a steep price through incarceration. If Forest Hills consumers had their way, Mr. Smart would be condemned to a much warmer, and eternal, confinement.

It is most likely that Mr. Smart has been making his deal through testimony given, and to be given, with respect to his transactions in Michigan and Tennessee. Mr. Smart’s Michigan caper has been detailed by the Detroit Business Journal in an article titled The Grave Robbers. CNNMoney has also chronicled the story.

By these accounts, Mr. Smart had no prior experience in either the funeral business or the cemetery business. Yet, with the help of ‘sophisticated financial advisors’, a self-promoting speculator exploited the laws meant to protect the consumers of both industries.

The Tennessee authorities cannot possibly make the Forest Hill consumers whole. When Smart took control of the Forest Hill preneed trust funds, its insurance investments were surrendered at substantial losses. Smart’s advisors wanted to put the money to better use. Consequently, the authorities need to make an example of Mr. Smart, and his friends. 

Those victimized by NPS (and the IFDA?) are hoping for some of the same justice. However, the issue of justice in Missouri is complicated by rumors of complicity between the preneed company and some of its industry members.
 

Missouri’s funeral industry has been given 30 days to submit proposals for revisions to the preneed law that went into effect last August 28th.  By email, the State Board has provided the guidelines for submitting changes that will then be discussed by the Board at public hearings to be held in June.  The Board has it’s own July 15th deadline to adopt any of the proposals and submit them to the Division of Professional Registration. 

For those operators who are displeased with the new law, the clock is running.

 

The Topeka Capital-Journal has identified the essence of the Secretary of State’s plan for Kansas cemetery regulation: addressing cemetery problems before the trusts go upside down.

There are two types of cemetery trusts: perpetual care trusts and preneed trusts. Perpetual care trusts (or permanent maintenance trusts) provide the cemetery crucial funding for mowing, and the other expenses related to care of graves, markers, roads and trees. Preneed trusts are required when cemeteries sell services and merchandise (such as vaults and markers) where delivery is deferred to a later date.

Both types of cemetery trusts have a funding liability that serves as its waterline. It is fairly common for a trust to ‘take on water’ when the value of its assets falls below the required deposit balance. As the trust takes on water, the operator’s liability will become so great that it will flip the boat, and take all aboard down.

A cemetery trust going ‘upside down’ can be an indicator the operator has used the consumers’ payments to pay bills instead of making the required deposits. These are challenging times for cemeteries, and some operators may find it easier to ‘borrow’ from the consumer than to go to the bank for a loan or to implement difficult business changes.

The Kansas Secretary of State has taken the position that it only has the tools to spot those cemetery operations that are listing dangerously to one side or the other. To avoid the expense of salvaging a shipwreck, the Secretary wants the ability to intervene earlier. To identify troubled vessels, the Secretary of State’s legislative agenda would have required monthly reporting from the cemetery operator and the trustee. However, the Secretary’s plan ran afoul of the industry’s supertanker: SCI.

At a legislative hearing, SCI took the position that the burden of monthly reporting “would greatly overshadow any benefit which could otherwise be obtained through the more practical option of annual reporting.” For the large, public companies subjected to regular reviews by the Securities Exchange Commission and the Internal Revenue Services, a state mandate requiring monthly reporting might be redundant and burdensome. However, the industry continues to be dominated by the independent operator, for whom the Secretary is the principal regulator.

In the next Kansas legislative session, certain compromises need to be struck for the benefit of the consumer. More frequent reporting should help flag irregularities that are symptomatic of the troubled operator. Independent fiduciary reporting is also needed as a cross check to what the operator is filing. And, if this is redundant to an operator’s existing reporting systems, the law could provide the flexibility to allow an operator to ‘clep out’ of monthly reporting.

The Springfield Journal-Register recently reported that Illinois’ Cemetery Oversight Task Force made a recommendation to restrict preneed trusts to investing in government-backed securities.   While its difficult to actually find that recommendation in the Task Force’s report, it is not a bad idea for the consumers who purchased a non-guaranteed preneed contract.  However, that type of restriction would hinder funeral homes that offer guaranteed contracts.

The safety provided by government-backed securities comes at a premium: a lower investment return.  Funeral homes and cemeteries are encountering cost increases that recently have outpaced the returns seen from insurance and trusts.  With regard to preneed trusts, investment return has often lagged behind cost increases because tax issues have been allowed to dictate investment policies.  

In the case of the IFDA, the trust resorted to insurance.  It is also very common to find preneed trusts invested exclusively in tax exempt bonds.  

If funeral homes and cemeteries are to offer guaranteed preneed contracts, applicable law should require trusts to adhere to the prudent investor rule.  While these trusts will always favor an asset allocation heavy with fixed income securities, a diversification is needed to provide protection and reasonable returns.  

 

  

A recent news report titled “Broken Trust” served to fan the emotions of Illinois residents who purchased a preneed contract from the Illinois Funeral Directors Association. The facts involve a 103 year old lady who purchased the contract 16 years ago, and experienced a 32% drop in the contract’s value in one year. The news report quotes from the funeral home’s website:

“By locking in today’s funeral costs and ensuring that the necessary funds are set aside, you help relieve yourself of unnecessary future worry and your survivors of an unexpected expense.”

The news report then adds: “For the Graces and thousands of other families in Illinois, it did not work that way.”

The news report goes on to add commentary for consumer advocates advising against the purchase of preneed. However, the news report is very misleading and serves to confuse consumers because of an important fact: Mrs. Grace purchased a non-guaranteed contract.

Contrary to what the article suggests, the Grace family did not lock in the 1994 purchase prices of the funeral home’s goods and services. They have every right to be upset about the recent drop in value, but so do hundreds of Illinois funeral homes.

Over the course of 16 years, Mrs. Grace’s preneed contract has realized an increase of 1.66%. Not a great return. The goods and services selected in 1994 to have gone up at a rate of 4.2%.

While a difference of $4,500 may exist between the value of Mrs. Grace’s contract and the current cost of the 1994 goods and services, the Grace family is not obligated to purchase that same funeral.  The family may choose less expensive goods and services.

The Illinois Comptroller has published various consumer guidelines regarding preneed contracts. All have an explanation of the differences of guaranteed and non-guaranteed.

To avoid unnecessary distress, consumers should read available disclosures closely, review the preneed contracts, ask questions of the funeral director, and involve other family members in the process.

For Illinois families who own a non-guaranteed preneed contract with diminished values, if you demonstrate flexibility over the casket selection, most funeral homes will reciprocate with regard to their services.
 

Within the past few years, state legislatures have significantly expanded the fiduciary duties of banks and trust companies that service death care trusts. Michigan, Indiana and Tennessee responded to cemetery trust frauds (including the Clayton Smart affair). The trend continued in Missouri and Illinois with laws aimed at funeral trusts (in response to NPS and the IFDA master trust). And, Kansas joined the movement with bills that are in response to cemetery trust failures.

At hearing for Kansas HB2712, the Kansas Bankers Association endorsed a provision that would require Kansas cemeteries to use fiduciaries that maintain a physical location within the state. The KBA reasoning is very simple: Kansas jobs. While the Kansas Secretary of State will accept the KBA’s support, the regulator wants the domicile requirement because the local fiduciary will be more responsive to the auditor’s inquiries and demands.

Regulators are not alone in their preference for the local bank. Funeral homes and cemeteries also take comfort in dealing with the bank that also handles their commercial accounts and their loans. Many funeral directors report that consumers also take comfort knowing their preneed funds are being supervised by the same banker who provides them checking services. Even consumer advocates recommend that individuals use the local bank to set up Totten trusts or POD accounts in lieu of preneed contracts.

However, the preneed trust and the cemetery perpetual care trust are not the type of accounts that most banks (or trust companies) handle with sufficient frequency to develop expertise. There is very little in the way of guidance to banks other than a 2000 memorandum issued by the Office of The Comptroller of the Currency to national banks.

Buried in the details of the OCC memo is the devil that trips up many preneed fiduciaries: the bank will be required to administer and invest the trust pursuant to the controlling instrument and applicable law. Applicable law would include the Internal Revenue Code, 12 CFR Part 9 and state death care laws.

The OCC memo warns national banks that:

Many banks serving as trustee in a preneed trust have only limited contact with the purchaser of the funeral contract and provider of the trust funds. The bank’s contact and business relationship is primarily with the funeral company. The consumer’s primary contract is with the funeral company or funeral director. Upon the death of the consumer, the bank remits the proceeds of the trust to the funeral company in accordance with the terms of the trust and contract, not to the individual’s family or heirs as is common in most trust relationships.

What makes this complicated and sensitive is that preneed funeral trusts are usually accounts established by funeral homes on behalf of individuals who are elderly or have limited financial resources. In addition, trustees manage these funds for a particularly sensitive and emotional event. Absent appropriate policies, procedures, controls and monitoring systems, this business line can create increased transaction, compliance and reputation risks.

Poor management of preneed funeral trusts, including weak internal controls over account acceptance and disbursements, noncompliance with trust agreements and applicable law, and inadequate due diligence on funeral homes and directors, can negatively affect a bank’s reputation. Banks that align themselves, or are affiliated, with funeral companies that have or subsequently develop reputation problems may themselves be tarnished, even if their internal practices are appropriate.

Preneed funeral trusts require the same level of supervisory oversight and risk management systems as other fiduciary activities in national banks. We expect banks that are active in this line of business to have appropriate strategic plans, policies and procedures, internal controls, MIS, and monitoring systems for this product. The administration of these accounts must comply with 12 CFR 9, Fiduciary Activities of National Banks, particularly the pre-acceptance, post-acceptance and annual review processes. It may be appropriate to have policies and procedures specific to this business line, and, if the business is significant for a bank, a separate administrative and investment review committee should be established.

It is imperative that national banks perform due diligence reviews on a funeral company before they enter a business arrangement with it. Bankers should also perform annual reviews of companies with which a bank has established a business relationship. Bankers should administer the use of third party service providers, such as investment advisors or managers, with appropriate controls and monitoring systems. National banks should also include preneed funeral trusts in internal compliance and audit programs.

While everyone from the consumer to the state death care regulator may take comfort in the local banker, few small institutions will have the revenues sufficient to warrant the costs associated with the compliance procedures recommended by the OCC.
 

In rejecting the $18 million settlement forced upon IFDA members, an Illinois Circuit Court is telling Merrill Lynch Life Agency to dig deeper into its pocket to compensate funeral homes. As reported by the Springfield Journal-Register, the $18 million represents the revenues the insurance broker received from the sale of key man insurance to the IFDA master trust. Apparently, Merrill Lynch convinced the Illinois Department of Insurance (DOI) that the funeral homes’ damages should be measured in terms of the benefit that Merrill Lynch received. But as the editor of the Memorial Business Journal* suggests, the Circuit Court seems more inclined to consider a ‘deeper’ measure of damages, and that will require the parties to the litigation to assess the master trust’s true loss.

The master trust collapse is framed by a ‘value’ that was set by a fixed return (2%) on consumer deposits. Based on that ‘value’, the loss is reported to be close to $100 million. But, one question funeral directors may be forced to answer will be whether the trust could have attained that value with the investment restrictions imposed by the members and the expenses taken by the IFDA. Another issue that may be raised is whether the IFDA’s past executives and attorneys bear some of the responsibilities for either selecting the investments or approving them. If so, comparative negligence may force the IFDA to shoulder responsibility for a portion of the damages.

The situation begs for a negotiated settlement, and it is unfortunate that time and expense was wasted on an end run with a regulator that had little, if any, authority over the IFDA master trust.
 

*"Reprinted with permission from the March 4, 2010 issue of the Memorial Business Journal. To subscribe please call 609-815-8145."

With two of the nation’s top ten college basketball teams, Kansans are exhibiting clear symptoms of March Madness. With Topeka located between Lawrence and Manhattan, bipartisanship may be tested as tensions mount this week with the Big 12 tournament and the NCAA seedings announcement on Sunday. When Kansas legislators resume their meetings the week of March 15th, they may hear from a third constituency that has a different ‘madness’ in mind: the Secretary of State’s cemetery legislation.

When the Secretary of State’s staff began holding hearings last June, HB 2712 and HB 2713 may not have been what they had in mind. With the intent to encourage industry input, the Secretary of State formed a committee of cemetery operators and state representatives that was to meet for an afternoon every two weeks. With an aggressive agenda in hand, the first meeting included a handful of ‘spectators’. After that initial meeting, attendance dropped and fewer cemetery operators participated in the process.

Undaunted, the Secretary of State staff held its meetings over the course of the summer and fall of 2009, and outlined the problems with enforcing Kansas’ cemetery laws: funding for audits, wholesale trusting requirements, ambivalent and uninformed fiduciaries, and underfunded cemetery trusts. At the conclusion of the committee meetings, the Secretary of State requested assistance from Kansas’ cemetery industry. When nothing concrete was offered by the industry, the Secretary of State offered options between a state-mandated trust or revisions to fix the current law. That portion of the cemetery industry that attended the meeting choose a fix of the current law.

Among the changes proposed by the legislation, the following may prove the most controversial to some cemetery operators:

  • The filing of monthly reports to the Secretary of State
  • A new fee based on the reported transactions
  • A switch of preneed merchandise trusting from wholesale costs to 50% of retail
  • A new fiduciary definition that will limit the institutions that may serve as trustee
  • An expansion of the fiduciary’s duties

While these bills do not reflect what the Kansas Secretary of State had hoped to accomplish when the process began last summer, the legislation reflects the realities of the current environment: growing political pressure to provide consumers greater protections and a fragmented and diverse cemetery industry.   Despite how some operators may respond, the Secretary of State could have gone much further (and may in future years).