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05/22/2012

Avoid The Preneed Shortfall Trap

by T. Scott Gilligan, OFDA General Counsel

            With interest rates at historic lows, many Ohio funeral homes are confronted with miniscule returns on preneed trust funds and preneed insurance policies.  In many cases, funeral homes are finding that the proceeds from trust funds or insurance policies that they received upon the death of a preneed consumer fail to match their at-need prices for the funeral goods and services they provide.  As a result, they have preneed shortfalls that are quickly eroding funeral home profits.  With some funeral homes performing one preneed contract for every at-need contract, preneed shortfalls threaten to drag their operations into the red.

            Why has this happened and what can a funeral home do to avoid preneed shortfalls in the future?  Preneed shortfalls happened primarily because funeral homes guaranteed the price of their preneed contracts in a market where interest rates cannot keep up with escalating operating costs.  A one to two percent return will not cover increases arising from health care, fuel or merchandise expenses. To cover those costs, funeral homes must routinely increase at-need prices to maintain a profitability level.  However, with guaranteed price preneed contracts, funeral homes are not able to increase prices to cover escalating operating costs.  The result, unfortunately, is a huge drain on profitability. 

            There are three possible solutions that a funeral home can implement to avoid the preneed shortfall trap in the future.  The first is to reevaluate their preneed investment policy.  Are preneed contracts being invested to obtain optimal returns or simply to generate commission earnings?  In other words, are you sacrificing long-term profitability for short-term gains?

            If a funeral home is looking to optimize preneed returns, it need not look any further than the OFDA Master Trust which in the last year provided a 5.9% return on market value.  Over the past three years, the Master Trust has had a remarkable 16.8% annual return while the five year look back (which captures a good part of the recession) had returns of 4.4% on an annualized basis.  However, even when the market value was not increasing because of declines in the stock market in 2008-2009, the OFDA balanced investment fund still provided a 2% minimum crediting rate.  The crediting rate, in combination with the ability to share in market value when the stock market increases, provides a funeral home its best opportunity to avoid preneed shortfalls.

            The second option to avoid preneed shortfalls is for funeral homes to eliminate the guaranteed price preneed contract.  The OFDA Master Trust now offers funeral homes the option of providing guaranteed price contracts or non-guaranteed price contracts.  Whether to offer the guaranteed price option is, of course, up to each funeral home to decide.  Some funeral homes feel that because consumers expect the guaranteed price product, they need to offer a guaranteed price contract.  Other funeral homes have made the decision not to offer the guaranteed price contract because of the risk of the preneed shortfall.  The decision is up to you.

            A third option that some funeral homes are pursuing is to offer the guaranteed price preneed contract, but to charge the consumer a surcharge for the guaranteed price option.  The surcharge, which is collected from the consumer, is then placed into trust or added to the preneed insurance policy to provide a cushion to reduce the risk of a preneed shortfall.  For example, if a funeral home decided to offer a consumer the option of guaranteeing the price of a preneed contract, it would list the price of that guarantee on its General Price List.  The consumer would then have the option of purchasing the guaranteed price option or accepting a non-guaranteed price contract. 

            With regard to the FTC Funeral Rule, there is no prohibition against offering the guaranteed price option.  As long as it is disclosed on the General Price List and recorded on the Statement of Funeral Goods and Services Selected when purchased, it complies with the requirements of the Funeral Rule.  As far as Ohio preneed law, the only requirement would be that the surcharge received from the consumer for the price guarantee would have to be trusted or be part of the preneed insurance policy premium. 

            There are a number of options when offering a guaranteed price option.  Some funeral homes charge a flat fee while others will charge a percentage of the preneed contract in order to guarantee the prices.  Another approach being used by some funeral homes is to offer guarantees of different lengths.  For example, we observed a General Price List from a funeral home that offered a five year guaranty at a certain price, a ten year guarantee at a higher price, and then a lifetime guaranty at a still higher price.  Below is an example of how this might appear on a General Price List:

• Preneed Price Guarantee for Five Years……………………. $______

• Preneed Price Guarantee for Ten Years…………………….. $______

• Lifetime Preneed Price Guarantee………………………… .. $______

            The purpose of the guaranteed price surcharge is to reduce the risk of a preneed shortfall.  As long as it is always presented as an option to the consumer, there is nothing unlawful about providing this option.

            OFDA members with questions regarding preneed funding may contact Scott Gilligan at 513-871-6332.