Death Care Law Blog

Michigan's Plan: Target Date Investment Strategy

Bill Stalter — Wed, 15 May 2013 12:23:43 -0600

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.

Illinois Tax Blues: when a loss is not a loss

Bill Stalter — Thu, 02 May 2013 12:53:10 -0600

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.

Wisconsin Cemeteries: Who needs a fiduciary?

Bill Stalter — Wed, 17 Apr 2013 12:07:04 -0600

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.

Missouri's First Preneed Regulation: if at first you don't succeed, try, try again

Bill Stalter — Tue, 09 Apr 2013 09:25:46 -0600

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.

The Trappist's Caskets: Does anyone's preneed law apply?

Bill Stalter — Sun, 24 Mar 2013 18:23:02 -0600

The monks of St. Joseph Abbey received good news in their battle to sell caskets when a Federal appeals court affirmed a lower court’s decision that struck down a Louisiana law that would have required the monks to either open a licensed funeral home or get a funeral director’s license. The District Court held that the restriction on casket sales amounted to a brand of economic protectionism that was not a legitimate state interest. The Court of Appeals applies a test that we find relevant to current controversies in Missouri and Kansas, but for this blog post we want to question whether the opinion would have been different if court had been asked to review the application of a preneed law to the preneed sale of Trappist caskets.

The purpose for preneed laws, protecting consumer payments until delivery is made, would seem to be equally applicable to funeral homes, cemeteries, casket stores, monument vendors or Trappist monks. However, most state preneed laws were written when the death care industry did not have significant competition for casket, vault and marker sales. Consequently, preneed laws are directed at death care licensees, and the occasional examiner or auditor will not be checking on the casket store to determine its compliance with the preneed law. If the casket store is making preneed sales, and marketing to out of state residents, multiple preneed laws could be implicated. The casket store’s website may reflect whether it offers deferred delivery. One of the Trappist’s websites offered the following:

Advance Arrangements

Peace of Mind for You and Your Family

Selecting a casket prior to need is a gift you can give your family. This arrangement ensures your wishes are met by securing your choice of casket for future use. By purchasing your casket in advance of need, you are relieving loved ones from making this often difficult decision, while closing your life's story on your own terms.

Purchase at Today's Prices Now, Ship When Needed

A pre-need arrangement with the Trappist monks of New Melleray Abbey allows you to purchase in advance, and have it shipped to the destination desired by your family at the appropriate time. You can rest assured the casket that you ordered will be available for immediate shipment when the time of need arrives.

We at Trappist Caskets feel very blessed to be able to so humbly provide these caskets, made with the work of our hands and with prayer in our hearts, to bring some small measure of comfort and solace to families in their times of need.

I hesitated to post on this issue because I love the Trappist’s ale so much, but preneed regulators need to be uniform and consistent.

Did Someone Ask "Who's the Boss?"

Bill Stalter — Sat, 16 Mar 2013 12:00:19 -0600

Three years ago we asked that question with regard to the power struggle occurring between the Missouri State Board of Embalmers and Funeral Directors and the Missouri Division of Professional Registration staff. That post was influenced by our experiences with preneed regulators from other states, who range from elected politicians to the revolving door bureaucrat. I would always prefer the experience and stability of a Dennis Britson or a Mack Smith, but they honed their skills over decades, and Missouri is under a bit of pressure to get reform rolling. With the Missouri Legislature having vested preneed supervision with the industry, we saw hope that Missouri could establish a unique structure where the experience of the industry would mesh with a staff with long term commitments. But silly me; the regulations drafted in response to a December vote on insurance assignments provide the answer to “Who is the Boss?” It is the Governor.

I must confess that my mind drifts at times when I attend the State Board meetings. Okay, I also check emails from time to time when the Executive Director gives her reports. But, the regulation proposals leave me wondering whether I was in the wrong room last December. But, Mr. Otto did whisper to me from time to time during the meeting I thought was the State Board’s. Maybe we were at a MFDEA meeting? Then again, I recall a unanimous vote that defined the insurance assignment as a preneed contract that was to be exempt from the $36 fee.

My warning from the “Who is the Boss” post in 2010 was this:

Death care operators are often frustrated when regulators take actions that demonstrate a lack of understanding of the business (or worse yet, a misunderstanding of applicable laws). The risk to both the death care operator and consumer is when the elected preneed regulator allows politics to influence the reform process. Elected regulators may pose the greatest challenge to developing effective preneed supervision, and then maintaining that system.

It is obvious the Governor doesn’t read this blog. Since 2010, an elected politician has made insurance assignments our preneed reform priority. I get it. The excess insurance proceeds could help offset the benefits paid to nursing homes, and Chapter 208 requires a Chapter 436 preneed contract. The State doesn’t want to revisit Chapter 436. It would be easier to manipulate the language of SB1 to get the desired result. (It’s not like the industry doesn’t do it too.) It took the State Board 18 months to offer a compromise, and one that was a win-win for the state and the industry. But, you are overplaying this hand by demanding the $36 per contract fee.

For the past two years, the industry and Board members have asked what the Division really needs in terms of fees to conduct exams. The answers have been evasive at best, but I could defend that response because the examination procedures are work in progress. But, your regulation proposals indicate that “The costs for the Board to administer preneed contracts is the same per contract, regardless of the value of the preneed contract.” If that is the case, then what is the cost per contract to perform a preneed examination? I find the Division’s budget for the State Board confusing, but the numbers attached to the agenda are significant. Is the Division receiving more that it needs, and if so, where do those funds go?

Up to this point, the examination procedures have focused on recordkeeping and confirming that consumer funds were deposited to banks and insurance companies. At some later date those procedures will need to look at how those funds are administered and paid out to funeral homes. But, until then, why is the $36 fee required on a transaction where the funeral director does not receive funds until after a death has occurred?

Three years ago I defended the slow pace of the Division, and advised the industry that reform required a shared responsibility between the Division and the State Board. Accordingly, please respect the Legislature and let the State Board perform its role for reform under SB1.

Obama's Plan to Tax the Rich: death care trusts

Bill Stalter — Sun, 10 Mar 2013 16:01:50 -0600

They say that the devil is in the details, and that is proving true for the Obama definition of the “rich” (those families that earn more than $250,000) and the plan to fix the budget. The IRS provided some detail to the Obama plan last December when it published a proposed regulation that would increase the Medicare tax to 3.8% and impose the tax on the rich through their trusts and estates. The NFDA and ICCFA have been trying to get their respective members’ attention because the proposed regulation specifically includes their business trusts as ‘rich’ that are be subject to the Medicare tax.

Sometimes it may seem that associations cry wolf to reinforce to the membership the need for the association. But, the proposed IRS regulation is somewhat unique in that it specifically identifies Section 685 qualified funeral trusts and Section 642 endowed care trusts as those which will be subject to the Medicare Tax. As both associations point out in comments submitted to the IRS, the proposal reflects how little the Service understands the purposes of these trusts.

To see each association’s comments click the following hyperlinks:NFDA ICCFA

There is a legitimate risk to qualified funeral trusts that do not make individual account allocations for composite filings. We would have thought most fiduciaries prepared QFTs in such a manner, but the Service’s comments from a few years ago suggests otherwise. And, what about those preneed trusts that have not taken the Section 685 election?

Even though the Service’s rationale for application of tax to Section 642 endowed care trusts is tenuous, these trusts lack the individual accounting ‘out’ that can save the QFT.

An Investment Strategy: the Man without a Plan

Bill Stalter — Sun, 03 Mar 2013 16:10:24 -0600

If you haven’t noticed, there has been some turnover among the associations’ preneed fund managers. With the threat of additional litigation in Wisconsin, this trend could continue. But not all of the turnover has been as publicized as what we have seen in Illinois and Wisconsin. After 20 years at the helm, Merrill Lynch recently gave notice to the Michigan Funeral Directors Association of its resignation. There are no search protocols for preneed fund managers, and so Michigan borrowed from the retirement fund community by publishing a request for proposal (RFP). While the MFDA should be commended in their effort to bring transparency to their program’s asset management, they missed (or ignored) an opportunity to shift more investment responsibilities to the financial industry. Instead of using FINRA Rule 2111 (“know your client”) to their advantage, the MFDA structured the RFP to perpetuate (and extend) the funeral director’s controlling role in investment decisions.

Hidden investment charges have been ‘part of business’ in the death care industry for decades, and this author has contemplated whether ERISA’s fee disclosure requirements could ever be incorporated into preneed trusts by the Federal Trade Commission. The Michigan RFP focused on the same ERISA fee disclosure requirements, which could lead one to assume that association’s leaders did not want to make the same mistake again. The Michigan RFP also raised another ERISA concept worthy of the preneed industry’s consideration: the 401K approach to investment by individual contract. We too have wondered why larger programs have not looked at data from individual contracts and the sponsoring funeral homes to build an investment options matrix.

But, the Michigan RFP can be faulted for cutting off the diligence requirements of FINRA Rule 2111. To insulate the Association from solicitations, the RFP provided summary information about the program and required all inquiries to go through an ERISA consultant. Prospective fund managers were required to submit investment strategies on limited facts and without direct communications to the Association. It is understandable that the Association would want to narrow the field before initiating an exchange of confidential information with prospective managers, but the screening of candidates should have preceded the request for investment strategies. Subsequent to the screening, the MFDA should then have provided detailed information pursuant to a confidentiality agreement. Under FINRA 2111, this sequence would have expanded the fund manager’s diligence responsibilities regarding investment strategy recommendations. The nature of the questions posed by the candidates would also have helped the MFDA in its assessment of the candidates. Instead, the RFP narrowed the fund manager’s diligence to an old investment strategy with a history of mixed results and challenges.

Within the context of ERISA retirement funds, RFPs may take a formula approach to finding a replacement fund manager. But the preneed industry is fragmented by 50 different state laws, and by program issues such as whether non-guaranteed contracts are sold, the association’s role as a seller versus an agent, investment restrictions, and trusting percentages. Injecting preneed asset management with a dose of ERISA could help to discourage hidden fees and improve the quality of fund managers, but the industry also needs an alternative to the strategy of offering funeral directors three investment options to choose from.

Master Trusts: Finding the Rails

Bill Stalter — Sun, 17 Feb 2013 16:26:16 -0600

Both the Memorial Business Journal and the Funeral Service Insider commented last week on the Milwaukee Journal Sentinel’s February 7th article regarding the former executive director of the Wisconsin Funeral Directors Association. Several issues were raised that should be included in future industry debate, and in particular, I would agree with Mr. Isard’s questions whether association executives are qualified to manage a master trust. But the following comments beg an immediate response:

“The whole situation with [the] Wisconsin Preneed Trust went off the rails when the goal shifted from trusting funds to investing funds.”

“The assumption that these trust funds are in the investment business is a mistake. We’re not. We’re in the trust business. From my view, that is a presumption of a preservation of principle. With a trust, you have an obligation to be prudent.”

Those comments suggest that trusting funds and investing funds are somehow mutually exclusive. While the comments may reflect the views of much of the death care industry, they also reflect a failure to understand the fiduciary’s duties. When entrusted with the money of another, the fiduciary has a duty to invest those funds consistent with the purposes of the trust and the interests of the trust beneficiaries. The fiduciary’s investment duties are governed by other laws, and a majority of our states have adopted the Prudent Investor Act. Wikipedia provides the following explanation of that Act:

In enacting the Uniform Prudent Investor Act, states should have repealed legal list statutes, which specified permissible investments types. (However, guardianship and conservatorship accounts generally remain limited by specific state law.) In those states which adopted part or all of the Uniform Prudent Investor Act, investments must be chosen based on their suitability for each account's beneficiaries or, as appropriate, the customer. Although specific criteria for determining "suitability" does not exist, it is generally acknowledged, that the following items should be considered as they pertain to account beneficiaries:

• financial situation;
• current investment portfolio;
• need for income;
• tax status and bracket;
• investment objective; and
• risk tolerance.

The majority of preneed trusts involve a single seller/provider and guaranteed preneed contracts. Under such circumstances, the funeral home operator has assumed the investment risk when the preneed contract is performed as written. Fiduciaries (and fund managers) have viewed the operator as the account beneficiary for purposes of the Prudent Investor Act. But depending upon state law, and whether the contract is ‘re-written’ at the time of death, the preneed purchaser may bear the investment risk. Accordingly, the fiduciary and fund manager should not completely ignore the preneed purchaser as the account beneficiary for purposes of the Prudent Investor Act.

Neither fiduciaries nor fund managers want to bring the preneed purchaser into the Prudent Investor equation for obvious reasons. But are suitability of investments for two that dissimilar? We would suggest not if the objective is to have investment performance track the prearrangement’s purchase price increases. As we noted in a March 2010 post about the IFDA master trust, the purchaser of a non-guaranteed contract was unhappy because the return on her non-guaranteed contract (1.7%) did not keep pace with the price increases of her planned funeral (4.2%).

Determining who to include as an account beneficiary in the Prudent Investor equation only gets more complicated when the preneed trust is an association master trust with dozens, or hundreds, of funeral home operators. If the master trust includes a healthy percentage of non-guaranteed contracts, the number of account beneficiaries could swell to the thousands. If the association is not the preneed seller (as is the case in Missouri, but not Illinois), what interest does the association have in the trust so as to justify being considered an account beneficiary? There are arguments in support of the association being such a beneficiary, but can those interests ever outweigh the funeral operator and the non-guaranteed contract purchaser?

One could argue that the Wisconsin Master Trust was never fully on the rails. The Association determined early on that a depository account could not keep up with rising funeral costs. Rather than seek legislation that would clarify the trust’s investment authority, the Association leadership sought regulatory permission to allow the master trust to embark on the path of investment diversification. The program derailed only after the executive director enmeshed his personal objectives with those of the association and then conspired with the fund managers to treat the association as the master trust’s primary account beneficiary.

Too Literal of an Interpretation: Mississippi and Preneed Taxes

Bill Stalter — Tue, 22 Jan 2013 15:30:24 -0600

The Mississippi Secretary of State seems to be taking a very proactive approach to the regulation of preneed and perpetual care funds. Over the course of the last few years, the Regulation and Enforcement Division of the Secretary of State’s office has averaged an enforcement proceeding per month. We were curious what type of enforcement proceedings they were pursuing, and picked one at random. The luck of draw involved a situation where the Mississippi regulators alleged the preneed seller’s preneed contract form did not adequately disclose to the consumer the tax consequences of their preneed trust. While the preneed contract form stated that income taxes may be withheld by the trust, the seller’s trustee reported the income to the contract purchaser. This did not set well with the Mississippi regulators, particularly when the consumer had no right to cancel the contract and receive a refund of the trust income.

The Mississippi regulators are not alone in their perception of the inequities of this situation. Nebraska preneed regulators are also questioning why income should ever be reported to consumers when they may never receive it. The answer is that the Internal Revenue Service forced this issue with Rev. Rul. 87-127, with the goal of requiring a single method of income reporting for preneed trusts.

The Service struggled with the situation that troubles the Mississippi and Nebraska regulators: how can the purchaser be the grantor if he/she is never entitled to a refund of the income (or even trust deposits) upon the contract’s cancellation. But, as between the consumer and the funeral home, the funeral home’s right to the trust corpus is dependent upon performance of the contract. While the consumer may never receive a refund, he/she can choose a different funeral home to service the contract. The value of that service satisfies the grantor rules of the tax code, and supports the IRS’ conclusions in the Ruling.

The inequity of the situation may have led to the passage of IRC Section 685. Given an alternative is available to the seller, the Mississippi regulators sought to force the seller to either change its contract or require the trustee to change its income reporting. But in doing so, the Mississippi regulators misstate IRC Section 685. Irrevocability is not a key characteristic of an IRC Section 685 qualified funeral trust. While the Section 685 election is viewed as irrevocable, the irrevocability of the preneed contract has no impact on Section 685. The Mississippi regulators also fail to acknowledge that Section 685 is the trustee’s election to make, not the funeral home’s. While the two need to work in concert, it is the trustee that has ultimate control over the trust’s income reporting.

Missouri's Preneed Reform: the 2015 Factor.

Bill Stalter — Wed, 02 Jan 2013 15:36:47 -0600

On January 14th, Missouri Governor Jay Nixon will be sworn in for his second term, and we are wondering whether the Governor’s plans for 2015 are influencing the direction of Missouri’s preneed reform. With commentary such as that published by the St. Louis Post Dispatch, the Governor may have his eyes on a 2015 campaign for national office. At a minimum, Governor Nixon could be targeting an old rival’s U.S. Senate seat. Either way, the Governor faces a nagging situation with NPS, and may feel compelled to accelerate preneed reform and deflect the criticism that has persisted for almost five years.

When National Prearranged Services collapsed in 2008, NPS funeral providers were especially critical of how then Attorney General Nixon settled the 1991 NPS lawsuit. The Attorney General’s office responded that they did the best possible with the weak enforcement powers provided by Chapter 436. Missouri’s Republican administration countered with a review committee formed for the purpose of finding industry consensus for preneed reform. But, the industry struggled to agree on key issues, and the State’s regulators took the lead in drafting Senate Bill. No. 1. In 2009, a newly elected Governor Nixon inherited the NPS fallout and a prior administration’s effort at preneed reform. Now four years later, the NPS fallout has somewhat abated (but not resolved), and there isn’t much to show in terms of preneed reform.

In contrast to the mortgage crisis or the state budget crisis, the NPS situation will not benefit from the recoveries of the nation’s economy or the financial markets. The Cassitys’ emptied the cupboards, and funeral homes are dependent upon the fixed recoveries negotiated with the state insurance guaranty fund. Most NPS providers are finding ways to cope, but one industry group persistently reminds the Governor and legislators of their discontent. The Governor would like to counter their criticism with evidence that preneed has been made safer under his watch, but it can take years to implement effective reporting and examination procedures.

As we noted in July 2011, a sudden increase in the number of financial examinations suggested that the Division was being pressured to accelerate the process. Shortly thereafter, the Division staff also began to press the State Board to define the insurance assignment as a preneed contract. The State Board and the Division staff disagreed on the insurance assignment issue, and frustration began to develop as the issue was pressed in subsequent meetings. That frustration culminated with a December 12th unanimous vote by the Board members to define insurance beneficiary designations as a preneed contract, but a preneed contract that would be exempt from the $36 preneed fee. Division staff warned that the distinction may not be legal. Within hours of the vote, the Governor’s office announced a Board appointment to replace Todd Mahn, the Chairman who had called for the vote.

The Governor’s website for Missouri’s Boards and Commissions states

"I am always looking for qualified, energetic applicants to serve on Missouri's 200-plus boards and commissions. Please spread the word. I would greatly appreciate it if you would encourage your colleagues and friends to review the vacancies and complete an application."

While this author has disagreed with some of the positions taken by Mr. Mahn, I do not question his commitment to the industry, or to the State Board. Nor did the former Chairman lack for enthusiasm and energy while serving the Board. But, rather than replace a Board member with known health issues that was serving on an expired term, the Governor replaced the younger Chairman.

It may not have been the Governor’s intent, but the appointment could be taken as message to State Board members to ‘get with the program’. But the Governor, and the Division, risk losing the confidence of both the Board and the industry. Someone has lost sight of the first issue discussed at the 2008 legislative meetings: who should have jurisdiction over preneed. Several state agencies attended that meeting, and none expressed any interest in assuming jurisdiction over the preneed transaction. As explained in a 2009 post, financial and insurance regulators often struggle to provide effective preneed oversight because they tend to focus on the ‘backend’ of the transaction (that part of the transaction they are most familiar). The front end of the transaction can take many different forms, which can push the transaction outside the normal scope of the agency’s jurisdiction. (For example, the Nebraska Insurance Department has jurisdiction over preneed sales, which includes trust funding.) When State Board members ‘stepped up’ in 2009 to retain jurisdiction (and demonstrate that the industry could provide meaningful self regulation), a collective sigh could be heard from the Missouri Division of Finance and the Missouri Department of Insurance. The Missouri legislature signed off on State Board jurisdiction, and in doing so made a trade off: reform would rely upon the collective experiences and training of six State Board members instead of an appointed department official. Governance by a board will never be the most efficient or expedient path to action.

In SB1, the State Board was given the task of protecting consumers against another NPS by developing procedures for preneed reporting and auditing. However, the Board is dependent upon the Division of Professional Registration for staffing, legal counsel, funding and reporting administration. Together, the Board and Division crafted a mission statement for the financial examinations that was to be the cornerstone of Missouri preneed reform. From this observer’s perspective, the State Board members never understood how the insurance assignment fit in to that mission statement. Explanations given to the State Board were unpersuasive, leaving an industry to wonder whether the issue was fee driven.

It may have taken the State Board a year to reach an agreement on the insurance assignment issue, but we believe the Chairman made the right call. This issue had a greater importance to the Division than it did the State Board, and there is speculation that the $36 fee, Chapter 208 and the state budget played a factor. Regardless, a resolution was needed so that the Board and the staff could turn to more substantive reform issues, including whether SB1 provides sufficient audit powers and protections. If the Division can look no further than the funeral home’s records, would SB1 have even stopped NPS?

The NPS Recovery Plan: Grounded!

Bill Stalter — Thu, 27 Dec 2012 15:36:36 -0600

In our prior post, we commented on the lack of detail provided by the Consumer Funeral Assurance group regarding their NPS recovery plan. We have obtained a copy of the plan, and redacted from the document correspondence that reflect names and/or contact information of recipient organizations or legislators. What is left includes a summary of the group’s proposal, which we find incoherent and difficult to understand.

The CFA was established when NPS first collapsed and funeral providers faced an information crisis, as well as an economic crisis. Five years later, funeral homes have a better understanding of what will be paid and when. While no one is happy about the situation, the immediate crisis of 2008 has been eliminated. So, today, it is not clear how many funeral homes count themselves as CFA members. That fact is not provided by the CFA in its NPS recovery plan.

The day may come when an NPS recovery plan is needed but the current CFA proposal detracts, rather than enhances, the group’s credibility with legislators and the industry. Accordingly, CFA members (and former members) should request that the plan be withdrawn.

The NPS Recovery Plan: two hurdles to liftoff

Bill Stalter — Tue, 11 Dec 2012 17:26:14 -0600

On December 12th, a Missouri coalition of NPS preneed providers will have a second opportunity to state their case for legislation to establish a NPS recovery plan. As we noted back in September, that coalition should anticipate a tepid reception from the State Board of Embalmers and Funeral Directors (and much of the Missouri funeral industry). Funeral operators may be sympathetic to the harsh economic realities of the guaranty fund’s ‘fixed recovery’, but few operators perceive how those future financial losses are ‘their problem’. Legislators cannot be as dismissive because the coalition is warning that it is a matter of time before funeral homes start to fail, and when that happens, consumers will ultimately suffer the financial loss. Not knowing whether two funeral homes or twenty funeral homes are at risk, the legislature gave the coalition a hearing to present a plan. The details remain vague, but it has been reported that the plan calls for a “mandated” preneed trust. If those rumors prove accurate, the plan has two major hurdles that could block its takeoff.

In concept, a state wide, cooperative preneed trust could provide financial relief to the NPS provider. A master trust could provide participating funeral homes the economies of scale to reduce administration expenses and increase investment performance. As a collective group, the NPS providers may be able to achieve a return that not only offsets the cost increases of the future preneed business, but also some of the costs of the NPS contracts yet to be performed.

But, any thought of using investment returns of future business to fund old business would have to be closely regulated. The trust cannot take investment returns from Funeral Home A contracts and allocate them to Funeral Home B contracts. Nor can the trust take investment returns from non-guaranteed contract a001 and allocate them to NPS contract b002. With the proper administration, the investment return of Funeral Home A’s new guaranteed contracts (or old Pre-SB1 guaranteed contracts) could be split with Funeral Home A’s NPS contracts. Such a split would occur only after the proper income/expense allocations have been made to originating accounts. Under Missouri law, the consumer of one of those new accounts could chose to designate a new provider, and transfer the entire account value (including the amounts allocated to the NPS contracts) to a new trust. Consequently, the level of administration required for such allocations would be complicated. If the NPS recovery plan should seek to short cut that administration with a fixed rate of return (and using excess investment returns to fund the NPS contracts), then the plan should be rejected.

The other hurdle to takeoff is the plan obtaining the requisite trust assets for economies of scale. The rumor is that the NPS recovery plan would require all Missouri preneed sellers to participate in the trust. (If mandatory participation can be required for the Obama health plan, then it can be required for the NPS recovery plan.) Kansas regulators floated a similar idea a few years ago and quickly withdrew the suggestion after hearing the initial response from operators.

A False Sense of Security: the hold harmless for investment oversight

Bill Stalter — Tue, 20 Nov 2012 15:31:32 -0600

We previously discussed how the funeral home or cemetery assumes most of a preneed trust’s investment risk when selling a guaranteed preneed contract, and therefore should be afforded a role in the trust’s investment decisions (Fund Managers: Is Your O&E Coverage Current?). But in that same post, we were careful to point out that there are no absolutes. More funeral homes are switching to non-guaranteed preneed. And, a certain percentage of guaranteed preneed contracts are also re-written at death when the family switches funeral homes or revises the prearranged funeral (or burial) arrangement. Yet, preneed fiduciaries seem to ignore these facts when relying upon uniform trust code provisions for their authority to exchange investment powers for a hold harmless agreement.

Death care fiduciaries first need to determine whether there are any conflicts between the applicable state death care law and the broader uniform trust code. Fiduciaries in states such as Missouri and Kansas are bound by statutes which require the trustee to retain investment oversight. Such conflicts will be reconciled in favor of the more specific death care law.

If the death care law is silent on investment delegation, the applicable uniform trust code may not necessarily authorize the trustee’s exculpation from investment oversight. Some states’ trust code conditions the fiduciary’s investment exculpation upon 1) the appropriateness of the trustee’s selection of the investment advisor, and 2) upon the notice given to trust beneficiaries. Illinois’ Trusts and Trustees Act is a good example of such a requirement. But too frequently, the fiduciary views the funeral home, or cemetery, as the sole beneficiary of the death care trust for purposes of both requirements.

Assuming notice could be given to each and every preneed contract purchaser, a court would likely evaluate the sufficiency of that notice from the perspective of the elderly preneed contract beneficiary. Would the average preneed purchaser understand the implications of the investment delegation? Or, could that purchaser effectively monitor the investment decisions made pursuant to the delegation? The fiduciary’s reliance on the uniform trust code for authority for exculpation under such circumstances should be deemed unreasonable. The validity of the exculpation may also hinge on the investment advisor’s assumption of applicable death care compliance requirements. If the agency agreement does not properly incorporate a death care law’s investment restrictions (or standard), the fiduciary has not exercised ‘reasonable care, skill and caution’ in establishing the scope and terms of the delegation. Yet, I hesitate to fault the fiduciary for trying. The strategy for seeking the exculpation is often in response to the unreasonable expectations of both the industry and its regulators.

As witnessed in California, regulators often interpret archaic preneed laws so as to argue that a ‘preneed contract is the equivalent of a savings account’. Those statutes reflect the preneed transaction from a generation ago. By applying that law out of the current context, a fiction is used to establish a standard that all fiduciaries could fail. The regulator’s position seeks to make the fiduciary a guarantor of the purchaser’s deposits to trust. The reality is that every trust investment has risk, even our government’s bonds. This exposure is applicable regardless of whether the preneed contract is guaranteed or non-guaranteed.

On the other side of the table, the industry is coming to demand that the trust offset more than just the costs of performing the preneed contract. Lagging membership revenues are an issue for many state associations. The mortgage crisis hit many preneed trusts, and preneed sellers expect those losses to be recovered without additional risk. Greater trust returns are also needed to offset the cremation trend. Of course, the asset management required for higher returns comes at a greater cost to the trust.

The reality is that the industry will continue to be request better returns from the death care trust. As with other trusts, the circumstances may dictate that as expectations rise, a fiduciary may best discharge its duties by delegating the investment responsibilities to an investment advisor. As discussed in the linked law review article, the model uniform code should be used to support the delegation of investment duties. But, in contrast to the classic trust situation, the death care trust is a creature of statute, which has the consumer’s protection as its purpose. While the preneed seller may be allowed to step into the settlor’s shoes for purpose of authorizing the delegation, the seller cannot override the preneed statute by exculpating the fiduciary from investment liabilities. At a minimum, the fiduciary needs to stand ready to override investments that are unsuitable or clearly imprudent. The two largest preneed scandals involved investments which were clearly unsuitable for the death care trust. Despite what Merrill Lynch may argue, I doubt any corporate fiduciary would have found the key man insurance policy to have been suitable for investment for a preneed trust. And if R.S.Mo. Section 436.031 had been written differently, NPS’ Missouri fiduciaries would have sought more information about the insurance transactions they were directed to make.

A Peace Offering: Fiducary Partners and the WFDA Receiver

Bill Stalter — Wed, 07 Nov 2012 10:13:58 -0600

Fiduciary Partners, the corporate fiduciary for the Wisconsin and Illinois master trusts, broke its silence this week with a statement to the Funeral Service Insider. The statement was made in response to criticisms previously reported by FSI, and reflects the receiver and fiduciary working together to get their “message” out and avoid the kind of litigation that has hamstrung the IFDA, its membership and the Illinois funeral industry.

FSI commentators used Fiduciary Partners’ link to the two states to drive home with funeral directors various preneed problems* including the management and investment of preneed funds, and the state of the guaranteed preneed contract and its impact on funeral pricing practices. While the issues need to be incorporated into a national dialog, Fiduciary Partners interpreted the FSI report as encouraging Illinois and Wisconsin funeral directors to assign blame to Fiduciary Partners. Consequently, Fiduciary Partners and the receiver felt compelled to respond.

As reported in a prior post, the WFDA leadership had muzzled Fiduciary Partners with a very strict confidentiality provision through an amendment to the master trust. Accordingly, the statement given to FSI has been made with the receiver’s approval, and could be taken as having the WFDA’s endorsement.

To neutralize litigation over the trustee’s role in administering investments, Fiduciary Partners and the receiver sought to clarify that the company had a very limited role that never included the management of investments. The message goes on to reinforce the need for Fiduciary Partners to continue to provide administrative functions related to individual contract accounting and performance payments. The statement also conveys a tacit acknowledgement of the WFDA’s secrecy, with Fiduciary Partner’s commitment to a new transparency.

It is inevitable that comparisons will be made between Wisconsin and Illinois, and to conclude that litigation may also be inevitable. However, one stark difference exists between the two situations: Illinois funeral directors faced a recalcitrant board that refused to acknowledge and correct its mistakes. That leaves the question whether Wisconsin funeral directors will bring litigation to recover damages. As one FSI commentator points out, damages will be difficult to measure when the association reported inflated numbers (through the guaranteed rate of return). And as the other commentator points out, member funeral directors need to take responsibility for hiring executives and fund managers that are competent and professional. It was their hire of an inexperienced executive that ultimately directed the use of trust funds to establish an insurance company.

The multi-million dollar question to be asked is what if Fiduciary Partners had responsibility for investment oversight? Would the trustee have been able to check Mr. Peterson’s actions? In our next post, we will look at the hold harmless provisions so popular in the preneed trust agreement.

*Reprinted from the Funeral Service Insider – October 29, 2012
**Reprinted from the Funeral Service Insider – November 5, 2012

To obtain a full copy of the Funeral Service Insider, contact www.funeralserviceinsider.com to subscribe.

Checks and Balances: Who has your back?

Bill Stalter — Fri, 02 Nov 2012 13:15:27 -0600

In the days that followed the Wisconsin Funeral Directors Association being placed into receivership, some of the WFDA’s sister associations were quick to point out they had ‘checks and balances’ that would protect consumers’ funds from the problems that tripped up the Wisconsin Funeral Trust. As we reported in our last post, a crucial ‘check and balance’ missing from the WFT was investment oversight. The fact that a trust has a corporate trustee does not necessarily mean that fiduciary has responsibility for monitoring the prudence of the investments. Corporate fiduciaries often look to uniform trust codes for the authority to delegate investment responsibilities. If a grantor wishes to use an outside asset manager, general trust laws will accommodate those wishes. The problem with preneed trusts (and cemetery endowment funds) is that there is more than one “grantor” to the preneed trust.

We have previously stated our support for allowing a relationship between preneed seller and a qualified fund manager. However, the fiduciary must provide a ‘check and balance’ to that relationship by maintaining responsibility for the investments. The ‘scandals’ from Missouri, Illinois, California and Wisconsin stem from a lack of investment oversight. Missouri’s regulators responded to NPS with a law that precluded any relationship between the advisor and the seller. Appropriately, the Missouri association obtained revisions to allow an agency relationship between its fund manager and the trustee. However, the Missouri law does not go far enough to require the disclosures we recommended in 2011. Funeral directors and consumers need to know that Missouri preneed fiduciaries ‘have their back’ when it comes to investment oversight.

Investment oversight is also a concern for cemetery regulators. Kansas’ cemetery regulators were dismayed to find that a corporate trustee had turned over the investment reigns to a Hutchinson cemetery operator. The operator hoped to cover declining revenues (and the failure to make trust deposits) with higher investment returns. For months, the operator attempted to hide the ball from the auditor, but eventually it was discovered that those investments had lost hundreds of thousands of dollars.

The investment supervision issue is also a concern for Nebraska regulators. As they prep the death care industry for legislation in 2013, they raise this issue:

Seller’s Power to Direct Investments

A question has arisen regarding the seller’s ability to direct the trustee’s investment decisions. Specifically, should the seller be able to instruct the trustee to deposit or invest funds in securities that do not meet the trustee’s own investment guidelines?

If it is determined that the trustee should be free from the seller’s investment influence, section 12-1107 should be amended to reflect this fact.

In what may be a perfectly legal arrangement, Illinois funeral directors have handed off investment oversight to their new fund managers. The master trust instrument carefully outlines the code provisions which authorize the delegation of investment authorities. But the document goes that extra step of exculpating the trustee from responsibilities for investment oversight. Where is the check and balance in that structure? Are the industry’s expectations so high that a trustee will not accept the fund without a hold harmless? If the industry does not establish its own ‘checks and balances’ with regard to investment supervision, the authority to participate in the investment decisions could be taken away.

Wisconsin: borrowing from the NPS playbook

Bill Stalter — Thu, 25 Oct 2012 15:59:44 -0600

Recent document disclosures are reflecting that several factors contributed to the WFDA’s master trust deficiency (and the appointment of a receiver). Certain of those factors relate to the fees paid to fund managers and the association’s sponsorship charges. Those factors are relevant to other association master trusts, and we will explore them in subsequent posts. However, the ‘straw’ that broke this camel’s back came straight from the National Prearranged Services’ playbook.

The Wisconsin State Journal reported that it was the formation of a life insurance company by the WFDA’s Wisconsin Funeral Trust that prompted a regulatory audit by the Office of the Commissioner of Insurance. In 2009, the WFDA used the master trust to set up an insurance company to provide its members a preneed funding alternative to the trust. Wisconsin law requires 100% of the consumer payments to be deposited to trust. In contrast, insurance funding provides funeral homes commissions to offset the costs of a preneed program. This same reality led National Prearranged Services to form a life insurance company. NPS needed an insurance program in order to expand into 100% trusting states. To jumpstart that insurance program, NPS tapped its Missouri and Texas preneed trusts.

NPS exploited a provision of the Missouri law that exculpated the trustee from investment oversight when an independent investment advisor was appointed by the seller. Held harmless by state law, NPS trustees may not have looked further than the statements the seller provided. NPS then appointed an investment advisor that directed the trusts into policies issued by the sister insurance company. In a similar fashion, the WFDA amended its master trust agreement in 2009 to remove the trustee’s investment responsibilities and authorities, and to vest investment control in the fund manager of the WFDA’s choice. And to top that move off, the amendment made information about the trust and parties confidential. If the trustee was unhappy with the situation, it could resign, but it could not make “any public communication that may be reasonably considered derogatory or disparaging to the Association, the Trust, the successor Trustee or any party relating to the Trust.”

There are indications the WFDA funeral trust had been struggling for years to keep up with promised return. But, over the course of three years, the WFDA made radical changes that culminated in the formation of the insurance company. Who was the driving force behind those changes? When advice was sought in 2007 to allow the trust to diversify its assets, the legal opinion was directed to the WFDA executive director Scott Peterson, not the corporate fiduciary.

A Call to Mark to Market: The NFDA

Bill Stalter — Sat, 20 Oct 2012 10:09:26 -0600

A short three and a half years ago, the funeral industry reeled from the collapse of National Prearranged Services and the emerging story of the Illinois Master Trust. The NFDA was slow to respond to the crisis, and when it did, this blog joined the criticism. Fast forward to September 2012, and the NFDA responds to the Wisconsin Master Trust controversy with the same guidelines.

Granted: associations are cumbersome organizations that are dependent on volunteer members.

Granted: changing the mindset of a membership that has been historically opposed to preneed will be difficult.

Granted: it is a matter of time before another state association master trust fails.

We need to augment the advice offered the NFDA in 2009: eliminate from your trust evaluation guidelines any suggestions that a guaranteed rate of return is permissible. The days of set rates of return or book/tax cost of account for distributions are over.

The fixed rate of return approach allowed the Wisconsin and Illinois programs to avoid investment transparency and individual account allocations of income and market value. But, providing investment transparency in terms of the investments held by the trust, and the rate of return, can be more complex that the NFDA guidelines suggest. It is not uncommon for three or more investment pools to be offered by a master trust program. Administrators may have different ways to provide transparency at the trust level, in terms of in investments held by the trust and their rates of returns.

Whatever procedure is followed, the end result should be a ‘mark to market’ that will allow an auditor to reconcile each individual preneed contract’s value to the individual funeral home account(s), and in the case of master trusts, each individual funeral home’s account(s) to the aggregate master trust market value.

Wisconsin: Where is the Love?

Bill Stalter — Sun, 14 Oct 2012 10:05:41 -0600

When news of the Wisconsin receivership was made public, I anticipated some signs of support from other state associations. The strength of a professional relationship can be measured by the support given subsequent to a public indictment. But, when that support comes in the form of hackneyed advice, the accused is left to wonder about the relationship. It should not come as a surprise if the Wisconsin Funeral Directors Association leadership was frustrated or angered with the National Funeral Directors Association or the New York Funeral Directors Association over the ‘advice’ given through trade journals.

When asked by the Funeral Service Insider for a response to the Wisconsin ‘scandal’, the NFDA recommended its model preneed law and referred members to its “Guidelines for Evaluating Preneed Trusts”. How would the model laws have avoided the Wisconsin scandal? Does the NFDA advocate investment standards that would permit diversification and the prudent investor rule? Would those model laws make the Wisconsin program more competitive with insurance companies?

If one were to review the NFDA’s Guidelines for Evaluating Preneed Trusts, you would find a section titled Rate of Return. That section includes questions about whether the preneed program provides guarantees about the rate of return on investments. It would be reasonable for the WFDA leadership to infer from the Guidelines that fixed or guaranteed rates of return are an acceptable method of master trust administration. So, that leadership has to be asking itself why they are facing a securities investigation by including that same guaranteed rate of return in preneed contract forms and consumer marketing materials. The WFDA leadership could have corrected its program and avoided the securities issues if those Guidelines had been revised years ago to recommend market value administration and the limitation, and disclosure, of the association fees charged to the trust.

The NYFDA association advises the funeral industry that state associations are uniquely well-positioned to deliver on preneed safety and security, and argues that competent executive directors and educated volunteer leaders can deliver what no other entity can. The NYFDA goes on to assert that return of principal is more important than return on principal, and that trust programs start to go off the rails when too much authority and oversight is handed over to third parties (that want to make money on the backs of funeral firms and consumers). What is the WFDA preneed committee (or other associations) to make of that advice? Are they to direct the trustee in making investments? Are they to ignore the demands of trust participants for higher returns? Are they to ignore the fact that New York is the only state to have laws that require 100% trusting and that bans insurance funded preneed? The reality is that state association preneed programs are under increasing pressure to improve investment returns. Unfortunately, associations are contributing to that pressure with the fees they are charging the trust.

During the past six years, four state sponsored programs have “crashed” due to fiscal problems and noncompliance. Minnesota, Illinois, California and Wisconsin all seemed to have respected executive directors and educated volunteer leaders. What roles did internal fees and outdated laws play in each situation? Would these associations have lost program participants (and the accompanying sponsorship fees) if they had provided more transparency regarding investments and internal fees?

I agree with Ms. McCullough that association sponsored master trusts are uniquely well-positioned to deliver on preneed safety and security. The problem is that too many have not delivered either safety or security. How many of these programs adhere too closely to Ms. McCullough’s advice? The affidavit that served as the tipping point for the appointment of the Wisconsin receiver paints a picture of a dominant association executive and an active and engaged volunteer board. Where were the compliance attorneys and the corporate fiduciary during the preneed committee meetings? Were they even invited? While there will be more pieces to the Wisconsin puzzle, what is available today suggests that the WFDA should have sought the input of “experts” instead of excluding them.

That Elusive Matter of Intent: Missouri insurance assignments

Bill Stalter — Fri, 21 Sep 2012 10:39:14 -0600

With the backdrop of another major preneed debacle, Missouri turns its attention (yet again) to the assignment of insurance policies to funeral homes. On September 25th, the State Board of Embalmers and Funeral Directors will consider a regulation proposal addressing insurance assignments. Is it, or is it not, a preneed contract? The industry, and the staff, need an answer.

The proposal establishes a presumption that all insurance assignments give rise to a preneed contract. I don't have a problem with such a presumption so long as the funeral home is given the opportunity to rebut that presumption. The regulation does provide a mechanism for rebuttal, but no guidelines are provided as to what would be excluded from the preneed definition. Instead, the intent of each funeral director must be examined, and to compound matters, the proposal references 'intent' twice. There is the question of whether the funeral director had intent to use the assignment for "payment in advance" for goods and services. And, there is also the question of whether the funeral director had intent to form a preneed contract. (We can reasonably predict the funeral director's answer to the latter inquiry.)

To avoid a circular inquiry in the mind of the funeral director (and an examination backlog), the Board needs to establish a set of facts that would reasonable exclude transactions that do not constitute the sale of an insurance funded preneed contract.