The Illinois Division of Insurance made the right call: the IFDA master trust does not have an insurable interest in the lives of the members who participate in the trust.

A preneed trust is intended to fund the liability that arises when the preneed beneficiary dies and a funeral must be provided. Accordingly, it is appropriate for a preneed trust to hold insurance covering the life of the contract beneficiary. At the time of death, the trust will receive insurance proceeds, and if the trust is established correctly, the proceeds are excluded from being taxed pursuant to Internal Revenue Code Section 101(a). The amount distributed by the trust to the funeral home is treated as ordinary income.

While the funeral director may have a financial interest in the performance of the preneed contract, the director’s death does not create a liability for the preneed trust. In the absence of a risk of loss, the policy held by the preneed trust is taxed as though it were an investment contract. Once the fiduciary factors in the tax consequences and the mortality charge, the decision to dump the key man policies makes sense.

Now the accusations turn to why this wasn’t done sooner. Or, why were these policies purchased in the first place. The broker’s excuse dodges the responsibilities he had to perform research, make inquiries and report accurately to the insurance companies.

Where was the IFDA counsel when these insurance purchases were being made?

Perhaps the regulators have exposure as well, but that may depend on what was disclosed by the IFDA (and when).
 

A little more than a month has lapsed since the Missouri legislature passed a reform preneed bill, but the death care industry remains stuck in neutral until Governor Nixon signs SB1 into law. 

With an effective date of August 28th looming two months away, regulators and funeral homes (and cemeteries) face licensing and document deadlines.  The State Board of Embalmers and Funeral Directors will have the task of licensing hundreds of preneed sellers and providers.  Preneed sellers will have the task of establishing new trusts and preneed contracts. 

This should make for a busy Show Me summer.

Federal and state regulators can not quite agree on how to define the preneed transaction.  Federal regulators tend to view the preneed transaction as a current sale of goods and services (where the delivery is deferred until a future date).  In contrast, state regulators are increasingly defining the transaction in terms that defer consummation of the sale until the beneficiary’s death.   This is reflected in a bill (SB1682) passed recently by the Illinois Legislature.

Through a deletion to 225 ILCS 45/1b (b), the preneed seller will no longer be allowed to retain a finance charge from the purchaser payments.  While not all preneed sellers include a finance charge on their installment sales, some do in order to offset the earnings lost when the purchase is paid over time.   

Like homeowner’s covenants, ownership of an interment right in a burial space comes subject to the cemetery’s published rules. Cemetery rules are used to regulate such issues as the planting of trees and shrubs, establishing uniform requirements for markers, the removal of decorations, and a transfer of the interment right. Consequently, it’s common for states to pass a law like Georgia’s Section 10-14-16 that subjects cemetery rules to a standard of reasonableness. That law was at the heart of a recent lawsuit that ended in a court order precluding a cemetery’s efforts to impose a “My way, or the highway” rule on lot owners.

Most cemeteries require the use of a vault to maintain the integrity of the casket and the uniformity of the burial spaces. As a consequence, the vault is an item that the funeral home and cemetery compete to sell. As the news article reports, most vaults are made out of concrete.

To gain the upper hand on his competition, the cemetery owner implemented a rule requiring lot owners to use a new type of vault made of a steel-polymer composition (that the cemetery had exclusive rights to sell). Putting aside a couple of ‘minor’ legal issues, this strategy should fail the reasonableness test if the newspaper’s reporting is accurate. The article attributes the following to cemetery owner:

….people who already bought burial plots and demanded concrete vaults could sell their plots and relocate to another cemetery.

Regardless of whether a lighter, stronger type of vault is a better choice, it is not reasonable to impose a new rule that forces existing lot owners to make a choice between purchasing that vault or selling their lots. Even if the cemetery’s attorney were to prevail on an appeal of the court’s order, the cemetery’s competitors have other legal challenges such as anti-tying violations or the impairment of contracts.

When Missouri’s Chapter 436/NPS reform legislation began to take shape last summer, the state’s cemetery industry sought to get out of the train’s way by incorporating new preneed provisions into a Chapter 214 bill. To clarify that cemeteries could establish preneed programs that would be regulated exclusively under Chapter 214, and not Chapter 436, statutory exceptions were drafted into Senate Bill 1 not once, but twice. To add a belt to those suspenders, a statutory exception for cemeteries was also drafted into the Chapter 214 bill. But alas, there has been a small slip between the cusp and the lips.

SB1’s two ‘cemetery exemptions’ are found at Section 333.310 and Section 436.410. Section 333.310 was intended to exempt cemeteries from the State Funeral Board jurisdiction and Section 436.410 was intended to exempt cemeteries from Chapter 436.

333.310 The provisions of sections 333.310 to 333.340 shall not apply to a cemetery operator who sells contracts or arrangements for services for which payments received by, or on behalf of, the purchaser are required to be placed in an endowed care fund or for which a deposit into a segregated account is required under chapter 214, RSMo; provided that a cemetery operator shall comply with sections 333.310 to 333.340 if the contract or arrangement sold by the operator includes services that may only be provided by a licensed funeral director or embalmer.

436.410. The provisions of sections 436.400 to 436.520 shall not apply to any contract or other arrangement sold by a cemetery operator for which payments received by or on behalf of the purchaser are required to be placed in an endowed care fund or for which a deposit into a segregated account is required under chapter 214, RSMo; provided that a cemetery operator shall comply with sections 436.400 to 436.520 if the contract or arrangement sold by the operator includes services that may only be provided by a licensed funeral director or embalmer.

Both exemptions define a cemetery preneed arrangement where the purchaser’s payments must be deposited to an endowed care fund or a segregated account. One problem with this is that endowed care trusts cannot be used for preneed payments. A second problem is that the segregated account arrangement was eliminated from the final version of SB296. The Missouri cemetery industry’s last chance for a statutory exemption, a new Section 214.320.5, fell victim to a last minute deletion from SB296.

Missouri cemeteries now face an uncertain future with a new Chapter 436, and an expanded Chapter 333.

Finding a fiduciary institution that is both knowledgeable and receptive has proven a challenge to funeral directors. Until a few years ago, the larger operators could rely upon the size of their trust to at least generate interest from prospective institutions. However, litigation exposures are now causing institutions to hesitate with even the largest of trusts, and the Illinois Comptroller’s proposed legislation would raise the fiduciary bar even higher for Illinois funeral homes.

If given the choice, state preneed regulators prefer that sellers use a ‘domiciled’ fiduciary institution. It is easier to hold domiciled institutions accountable under the preneed law. However, the preneed regulator’s jurisdiction begins to ‘cloud’ with regard to a foreign state-chartered institution, or a federally chartered institution that is not “located” within the state.

The Illinois Funeral or Burial Funds Act, like other states’ preneed laws, has an ambiguity that opens a ‘back’ door for foreign fiduciaries. While paragraph (b) of Section 225 ILCS 45/2 contains language stating the preneed fiduciary is to be domiciled in Illinois, paragraph (f) authorizes the use of foreign fiduciaries without the institution subjecting itself to the jurisdiction of state regulators. The Comptroller is now looking to close that ‘back’ door by deleting paragraph (f). The consequence to the Comptroller’s proposal would be to require the foreign fiduciary to comply with the Illinois Corporate Fiduciary Act.

Each state has a law governing the fiduciary activities of foreign institutions, and some are more liberal than others. State chartered institutions have no choice but to comply with these laws if it is deemed that the fiduciary services are being rendered within the state. In contrast, OCC and OTS chartered institutions will generally assert federal preemption arguments. With regard to both state chartered and federally chartered institutions, the language of the preneed law and the preneed contract are relevant to the issue.

The Texas Department of Banking addressed these issues in a 2001 opinion, with a compromise of sorts. In reaching that opinion, the Texas attorneys were mindful of the 1998 OTS opinion obtained by Forethought Financial Services. While on its face, the OTS opinion reads as a “Pass Go” and Collect $200 card, certain representative facts undermine the opinion’s value. State preneed regulators will invariably dispute the facts asserted by the “Association” at the bottom of page 7 of the opinion.

Following the Texas lead, state preneed regulators need to be flexible with foreign fiduciaries willing to comply with their state’s preneed law without ‘locating’ within the state.

It may be a mere coincidence, but the $9.7 million demand made by Comptroller Dan Hynes upon the IFDA is approximately 25% of the $39 million dollar “deficit” that the master trust had accrued by 2006. In applying the letter of the law, the Comptroller has rejected the IFDA approach of crediting individual preneed accounts with a fixed rate of growth. Instead, the Comptroller has taken the position that the 25% administration fee must be based on actual trust income, and the IFDA has failed to adequately demonstrate what the trust has earned.

As more information is released about the master trust, the more it appears that the IFDA structured the master trust to simulate a defined benefit pension plan. By establishing a fixed rate of return acceptable to funeral providers, the IFDA could apply actuarial studies to project the trust’s liability at future dates (and invest accordingly).

A generation ago, the defined benefit plan was the principal method for funding retirement benefits. Today, however, the 401K plan has replaced the defined benefit plan as the retirement vehicle of choice. Defined benefit plans have proven too costly.

If some twenty years ago the IFDA in fact chose to emulate the defined benefit model, that decision was flawed from the start. Defined benefit plans are subject to extensive rules and procedures established by ERISA. Investments, allocations, related party transactions, expenses and taxes are all subject to strict rules and tests. There are no comparable laws and regulations for preneed trusts. Without similar guidelines and supervision, the IFDA appears to have broken most of the ERISA rules.

When funeral directors fault the Comptroller for not having acted sooner to avoid the trust’s decline in value, they are failing to understand that a substantial portion of the amount written down prior to 2008 represents an accounting change from the defined benefit ‘value’ to the trust’s current approximate market value. There was nothing the Comptroller could have done to prevent that ‘deficit’ from being written down.

With regard to the trust’s value decline since 2007, the key man insurance held by the trust poses a thorny problem. The insurance policies have a mortality charge that must be satisfied from a reserve that is probably invested in a volatile mix of fixed income and equity assets. Surrendering the policies requires the trust to address certain tax penalties and policy fees, unless of course, the policies are rescinded or fail to constitute insurance.

Where does this leave the IFDA and the Comptroller’s $9.7 million claim?

Unless the IFDA has assets (including its museum of funeral customs) sufficient to pay the claim, it will have to earn its way out of this hole. As with most state associations, the master trust represents its main source of revenue. Administrative fees charged to members range from 75 basis points for large trusts to 125 basis points for smaller trusts. Besides individual account administration, these fees must also cover fees for the fiduciary, asset management and tax administration.

In a prior press release, the Illinois Secretary of State put the IFDA trust value at $200 million. For a trust this large, account administration could conceivably receive a fee of 35 to 50 basis points. Assuming the IFDA’s costs to provide such services were $250,000, the association could net $750,000 per year. If the IFDA could apply half of that fee to the Comptroller’s claim, the association is still looking at a very long row to hoe.

But the Comptroller has reasons to consider this alternative. If the claim should prove the final straw that breaks the association, the IFDA master trust may have to be broken apart and transferred to new trusts established by the individual members. This is what happened a few years ago with the Minnesota master trust. The difference with the IFDA situation is that hundreds of members are involved instead of dozens. It would be the Comptroller that must supervise hundreds of trusts instead of a single trust.

At the risk of plagiarizing the Missouri Funeral Directors and Embalmers Association, Missouri preneed funeral sellers, providers, fiduciaries and insurers face a new ballgame that will begin August 29th without a complete set of rules and guidelines. Funeral directors have a general idea where the game will be played, but they’re not quite sure what rules the umpires will use or how closely the game will be called.

In contrast, Missouri’s cemetery industry has been left to guess where their game will be played. Through last minute changes, the cemetery bill was pared back to those essential provisions required to authorize trust-funded preneed sales and a fixed-distribution provision for endowed care trusts. The resulting provisions do not begin to tell the underlying issues.

Funeral directors get the first crack at learning their new ‘rules’ on May 28th when the MFDEA sponsors a session with the Chapter 436 umpires. Based on the success of that session, one of the 436 umpires (the State Board) will probably explore regional meetings with funeral homes.

In the meantime, Missouri’s cemeteries will need to regroup in an effort to work out a consensus on preneed and endowed care legislation.

For a copy of the changes to Chapter 436 click here, and for Chapter 214 changes click here.

The battle to reform Illinois’ preneed funeral law was renewed by the Comptroller’s office with the release of his Amendment to Senate Bill 1862. Reform in Illinois will take months, and the final product may differ substantially from the Comptroller’s proposal. However, SB 1862 flags Mr. Hynes’ priorities, and one of those priorities could force a shotgun marriage between the IFDA and some of the small funeral homes critical of the Association.

The Illinois preneed law authorizes a preneed seller to act as its own trustee when the seller’s preneed funds are less than $500,000. This provision is a reflection of the difficulty and expense encountered by small operators attempting to find affordable trust services. However, the IFDA exploited this provision with regard to its master trust, and consequently, the Comptroller wants to eliminate the self-trusted arrangement.

The advantage of an association master trust is that it provides the requisite economies of scale to provide affordable trust administration to the smallest funeral home operator. But, many Illinois operators shunned the IFDA master trust because of a lack of transparency. The amount of preneed funds held in self-trusted arrangements could be substantial. If the Comptroller seeks to apply the elimination of the self-trusted exception retroactively to existing trusts, the cost of corporate fiduciary services and the scarcity of such fiduciaries may lead these operators back to the IFDA, perhaps with the numbers to force changes at the Association.

The New York preneed law may be the best consumer oriented preneed law in the country (see Page 47 of the AARP Survey). It requires 100% trusting, the accrual of income and limits the permissible investments. The New York State Funeral Directors Association has good reason to be proud of their preneed program. Yes, their preneed trust is safe and steady. But, it is a one-of-a-kind model that owes a certain amount of its success to New York’s restrictions on insurance funding.

The bar set by the NYSFDA for other state associations is impossible to obtain in today’s legal environment. The last sentence from a recent article about the IFDA’s woes is most telling:

“The only lobbying we’ve had against our laws is from the insurance industry, which would like to bring their products into New York.”

Other than New York, what states prohibit insurance funded preneed contracts? States that consider the New York standards without insurance funding restrictions need to examine the consequences to the consumer and to the funeral home operator. If trusting requirements are set too high, operators will resort to insurance funding for their preneed contracts. Funeral directors will have insurance licensing requirements to fulfill, and consumers will have fewer preneed options.