Final Committal Texas problems With Pre-Paid Funeral Services A report prepared by Consumers Union SWRO October 2000 available in pdf format

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Phantom interest/Real taxes When the funeral home charges families for services that were not covered in the preneed contract, family members start looking for the interest that should be available from the trust account. Mrs. Trudy Adelmeier bought a preneed funeral service contract and mausoleum space for a total of $4,745.50 in 1984. In 1998, the funeral home sent a letter pressing Mrs. Adelmeier to pre-pay for entombment as well. “In 1992 it [entombment] cost only $400. Today, six years later, it has doubled in cost to $850, rising $100 in just the last few months,” the company told her. “Since this cost is climbing rapidly, I urge you to freeze the current cost at this time. You can do so with monthly payments of only $25, at no interest.” But her family wanted to know what had happened to the earned interest on her account. At current CD rates, the value of her account should have doubled. “What happened to the accumulated interest,” her son-in-law asked the Funeral Service Commission.(26) Unfortunately, under current law the interest will not be used to cover services not included in the original contract, even if it is more than enough to cover price inflation on the covered items. A typical contract reads, “Excess benefits--The funeral provider agrees to guarantee prices though current retail prices may exceed death benefits at the time of performance. If death benefits at that time exceed current retail prices, any excess death benefits may be retained by the funeral provider.” (27) The funeral home may keep the excess interest. In addition to any charges not covered by the preneed contract, families who use a pre-paid funeral trust or annuity to cover funeral expenses also discover that they must pay taxes on the interest income earned by the trust, even though all the interest income goes to the funeral home. In 1993 and 1994, Cynthia Strauss pre-paid $500 per month for her mother’s funeral, a total cost of $9,122. She received annual notices of the interest income reported to the IRS—more than $3,000 by 1999. Yet, when her mother died, the funeral home said she would need to pay an additional $1,200. “At that time, I asked the home what had happened to the interest,” she wrote to the Attorney General. “After all, I had been receiving 1040 notices that the income had been filed with the IRS. The director said he did not know what would happen to this money, but to his knowledge no one ever got it back.” (28) Claud Herring of Houston purchased a pre-paid funeral agreement in 1985, funded through an annuity. When he died in 1998, his surviving wife wrote to the Texas Department of Insurance to ask about the tax bill. In its response, the insurance company told her that the funeral home keeps the interest in order to cover the higher costs of a funeral with inflation. However, Mrs. Herring was the owner of the annuity, and therefore would have to pay taxes on the interest even though that interest income was never reported to her until it was finally distributed to the funeral home upon her husband’s death. “Is this standard practice,” she asked. “Have I overlooked something in that too-small-print to read in the contract?” (29) Unfortunately, it is standard practice. According to the Texas Department of Banking, IRS Ruling 87-127 requires families to pay tax on the interest income even though all the interest is retained by the funeral home. This holds true even if the consumer cancels the contract and the funeral home does not have to actually perform funeral services but still retains the interest on the account. (30) Minda Dominguez of Houston wrote to the Funeral Service Commission to complain when she received a tax bill on $1067 in interest accrued on her mother’s annuity backed preneed policy. “Had we known our monies were going to be invested in an annuity, we could have done that ourselves instead of paying upfront for my mother’s funeral expenses,” Ms. Dominguez said. (31) But if consumers save for future funeral needs on their own, there wouldn’t be money for the funeral insurance industry. A handful of insurance companies specialize in funding preneed funeral contracts. According to these company annual reports to the Texas Department of Insurance, preneed funeral is a lucrative niche business. Funeral Directors Life Insurance Company, primarily a Texas preneed insurer, collected $47.3 million in 1998 Texas premiums, and paid dividends and benefits of just $19.9 million. The company reported an increase in net income of 93.3% from 1997, and “extremely positive cash flow.” (32) Forethought Life, an affiliate of Batesville Casket Company with $2 billion in assets, collected $21.7 million in Texas premiums and paid out only $10.3 million. The company reported record insurance revenues for the second quarter of this year. (33) American Memorial Life Insurance Company, a subsidiary of SCI with business primarily in Texas, California and Washington, collected $110.3 million in premiums and paid out only $54.6 million in 1998. (34) Altogether, these companies reported loss ratios (the ratio of benefits paid out to premiums collected) of less than 50%, making preneed insurance policies comparable in value to credit life insurance—a nortoriously bad deal from the perspective of the consumer. Recommendations: Texas legislators should: require the fiducary to generate a simple annual report to consumers of principal and interest in a trust account or annuity and any taxes paid on the earned interest; and require the insurance company or trust fiduciary to report, at time of death, the amount of benefits paid to the funeral home under the policy, and require any benefit in excess of the cost of the funeral at the time of death (as described in the current price sheet) to be payable to the family or a designated beneficiary. Cancellation and small refunds Funeral homes must deposit payments for preneed funeral services or merchandise into a trust. But, the funeral home keeps a substantial portion of the early payments. Cemeteries must place in trust money for preneed cemetery services (like “opening and closing”) but not merchandise (monuments, plots, crypts). So if a consumer changes his or her mind, the refund may be minimal, especially if the purchase includes both funeral and cemetery merchandise. Nearly 20 percent of complaints related to requests for refunds on cancelled or changed preneed policies for funeral or cemetery merchandise and service. Winell W. cancelled her preneed funeral contract, but the company refunded only half of the money she had paid in. But according to the company, her refund was in accordance with Department of Banking regulations, and the consumer should have read her contract more closely. (35) For trust funded arrangements, Texas law grants the funeral home one half of each payment until 10% of the original funeral cost has been covered.(36) For most consumers, this means that about half of their total payment will be refunded if they cancel in the first year. After that, the payments are fully deposited into the trust and the consumer may get the amount in the trust (or 90% of the amount paid) back—but not the earned interest.(37) If a consumer wants to cancel a preneed whole life insurance policy, current law requires the insurance company to refund only the “cash surrender value” of that policy—a fraction of the amount actually paid in premiums (see sidebar on whole life insurance, p. 12). Finally, a consumer’s cancellation rights may be affected by clauses that “irrevocably assign policy ownership” to the funeral home. Such clauses assist those on Medicaid (often in nursing homes) because the insurance is not counted as an asset. However, once a consumer signs ownership of the policy over to the funeral home, even the cash value will not be refunded upon cancellation. Maria G. of Harlingen bought a preneed contract in November, 1996 with payments over ten years. About a year later, she decided to cancel it, but according to the company “at the time of application she had elected to irrevocably assign her policy ownership to the American Memorial Funeral Trust. This election does not allow for surrender of the policy and we advised Ms. Gonzalez that she did not have the option of surrendering her policy. Under the trust agreement, payment of the policy values is only authorized to the funeral home or mortuary providing funeral services and merchandise.” In other words, she would not receive even the minimal cash value of her policy back. (38) Consumers do not always understand the effect of “irrevocable assignment” when they buy a policy. Carlos Garza of Edinburg initialed a box on his preneed contract stating that he “designates this Agreement as: Irrevocable.” According to Mr. Garza, the agent told him that this clause would protect him from cancellation by the insurance company. “As it turns out, they are protecting themselves from the insured person canceling the insurance,” he wrote to the AG.(39) Irrevocable assignment may serve a good purpose for people who are spending down their assets in order to qualify for nursing care through Medicaid. In Texas older individuals are eligible for Medicaid if their monthly income is less than $1,536, and they must have fewer than $2,000 in assets other than a homestead. Couples may have an income of $3,072 each month and $3,000 in assets. People on a small fixed income with few or no assets to protect, people already eligible for Medicaid, and people who do not intend to use Medicaid do not need to sign their policy away.   Recommendations: Texas legislators should: require 100 percent of a consumer’s payment to be placed in trust; give consumers who cancel after the 30 day “free look” a full refund of payments plus interest less a nominal administrative charge representing the actual cost of setting up the account; and increase the cash value available from an insurance backed contract to ensure that refunds will be no worse than refunds available from trust backed preneed contracts.  ______ Notes: 26 Funeral Services Commission, Consumer Complaint File 99-048. 27 Preneed Funeral Agreement and Assignment Price Guaranteed, Homesteaders Life Company, Rev. 03/01/95. 28 Office of the Attorney General, Consumer Complaint File S9903-0008. 29 Texas Department of Insurance, Consumer Complaint File 377616. 30 Letter to Cynthia Strauss from Lucy Pena, Texas Department of Banking, May 19, 1999. IRS Ruling 87-127, Situation 4. 31 Funeral Service Commission, Consumer Complaint File 99-118. 32 Funeral Director’s Life Insurance Company, Statutory Annual Statement, 1998. 33 Forethought Life Insurance Company, Statutory Annual Statement, 1998. 34 American Memorial Life, Statutory Annual Statement, 1998. 35 Office of the Attorney General, Consumer Complaint File M9907-0016. 36 Tex. Fin. Code Sec. 154.252. 37 Tex. Fin. Code Sec. 154.254 . Texas law requires the funeral home to refund at least 90% of the amount actually paid by the consumer, but does not require payment of interest on the account. 38 Texas Department of Insurance, Consumer Complaint File 359230. 39 Office of the Attorney General, Consumer Complaint File M9810-0081.