Friday, March 20, 2009

"Trust" Is A Funny Word With Pre-Paid Funerals

As if further evidence of the manipulation and misrepresentations, coupled with a relaxed or unenforced regulatory environment, associated with pre-need funeral contracts was necessary, the Illinois Funeral Directors Association is now embroiled in two lawsuits alleging the group mismanaged a trust under their oversight.

In fact, calling this vehicle a "trust" is an oxymoron in itself. Under their supervision, the investment trust, which was set up about 30 years ago to invest funds collected by IFDA members who sold pre-paid funeral contracts to consumers, resulted in a $60M deficit last year. At year-end 2007, the ending balance of the trust was more than $300M, representing 49,000 Illinois consumers who "trusted" the funeral directors who sold them. The IFDA contends that they have routinely paid out more for funerals than the value of the contract and their investment strategy of purchasing life insurance policies that invested heavily in corporate bonds was hit hard when corporate bonds went the way of the rest of the economy, doubling the deficit.

Now I do not proclaim to be an economics genius, but I do have some experience with money management, running a business and oversight responsibilities. Their entire premise is flawed from the get go. First, the cost of a funeral is driven by the funeral directors. Using emotional and pressure selling techniques to up-sell consumers and wholesale markups of up to 700% naturally result in higher cost funerals. So, if the contracts they sold were inadequate to cover the inflated funerals they cause, it seems reasonable that they could control and eliminate that shortfall. For instance, rather than selling a casket for 700% over wholesale, sell it for only 300%, or instead of charging $50 for a military bugler, who by the way volunteers his time, charge what is fair which would be nothing, whereby the contract coverage may be adequate. When funeral directors arbitrarily set the final price of a funeral, it is all negotiable. But, like all things, there's a can't have it both ways. You can't sell a pre-paid contract for "x", deplete it immediately by taking administrative or other fees, then employ markups and other practices that drive the final cost of a funeral to exceed the value of the contract you sold to cover it. That's not economics...that's common sense.

Second, what kind of investment strategy takes the entire fund and invests in one single strategy that is market sensitive and not guaranteed? The answer is an investment strategy that is doomed to fail. Since this capital was the fiduciary responsibility of the IFDA, it's logical to think that at least some, albeit most, of the investments would be in steady but unexciting vehicles like U.S. Treasuries or indexed. I believe there is a name for betting the house on one idea...gambling. The IFDA gambled with the "trust" and investments of 49,000 Illinois consumers.

And the cherry on top of this distasteful delight is that state regulators, who clearly failed to "regulate", renamed Merrill Lynch Trust Co. as the new trustee last November. Now, we all have been witness to how trustworthy Merrill Lynch is. Does the madness ever end!

Pre-payed funeral contracts are ripe for exploitation and fraud by design. There is no federal oversight, it lies with the state in which the funeral home does business. State by state, these contracts lack uniformity of language, content or format outside of general contract guidelines, with some (few) states providing explicit parameters and others providing little to absolutely none. There are no standard or best practice codes regarding the consumers ability to modify, cancel or transfer the contract or the method of reimbursement should the funeral home be unable to fulfill the obligations or declare bankruptcy. The method of investment by the funeral home is not standard, with some commingling funds and others holding individual accounts for each payee, and no guidelines on interest income or ongoing administrative or other fees, among others. The licensing grid is confusing and inconsistent, with some states requiring no license whatsoever to sell a pre-payed contract as a representative of a funeral home. And, here's the kicker, some states allow for the funeral home to retain whatever funds are left over rather than returning the funds to the family or estate. It's almost like a custom designed framework to fail.

Stories like the IFDA and so many others will continue until pre-payed funeral contracts fall under the jurisdiction of the FTC, with explicit rules and guidelines similar to "The Funeral Rule", as opposed to putting the fox (funeral directors) in control of the hen house (consumer pre-paid contracts). Until then, consumers will continue to "trust" the funeral director of their choice to do the right thing. A sad state indeed.

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