This may seem like a “Yawner” topic but it’s important and I am going to make it short.
Let’s pretend that you walk into a bank or trust company with, say, 15 contracts totaling a $100,000 in prearrangement value. You say to your banker that you want him to track each contract separately, invest in “no-risk” investments and not tax anyone on the growth when it is paid out.
Your banker responds as follows: “Mr. Funeral Director, here is what we will do for you:”
- I am going to credit your account on the first day for $110,000 on your $100,000 deposit
- Going forward we are going to pay a fair interest on the bumped up amount.
- I am going to cut you a check for 10% of the $110,000 we credited your account for and will continue to pay you cash for each new deposit on the same terms
- For those installment payments I am going to keep track of collections and process the payments AND credit your account in full for more than the prearrangement amount from day one. So if they die before they make all their payments you get the whole amount…our loss, your gain.
If you can imagine a bank or trust company doing that for you it must be connected with Bernie Madoff. But that is exactly the difference in using insurance over trust.
Because I have a financial background and more than 25 years negotiating with insurance companies a number of funeral homes have asked me to analyze AND compare their insurance product. I do this using methods similar to what they use for their internal purposes.
A lot is said about growth and shortfalls. Trusts offer a higher growth factor…or so everyone thinks. With bumpup and commissions all in the reality is the true economic value of most insurance products far outperforms trusts. Funeral directors lock in on the individual shortfall and completely ignore the front end benefit they have already received (this is called stepping over dollars to pick up nickels). It turns out that when I compare insurance products I frequently find first year growth in excess of 20%.
Did you know that simple growth can be converted to compound growth? I compare all products based on the actual Compound Annual Growth (CAGR). The early years are higher than later years but often show double digit rates.
More next week
Is the bump you mentioned without cost to the client or the funeral director, or is paid by additional premium?
Good commentary
Bill Bernhardt
The bumpup is a result of applying premium dollars to the prepaid amount. By law, insurance must contain a risk factor for the company. Hence discounted premiums. For example, a $5,000 face policy may have a premium for a single pay of $4,750. It has been common practice for funeral homes to make the prepaid amount the same as the premium resulting in a “bumped up” face value. For Example, let’s say that the prepaid amount at today’s prices comes to $5,000. Instead of funding it at the lower premium of $4,750 the premium is $5,000 and the face value at issue is $5,263. I know you expected the bump up to be the same as the discount. It’s not. but that is another story for another day.
Alan,
Excellent points. People need to look at the whole picture over the life of an insurance contract, plus the record keeping and tax benefits. Focuing on shrotfalls is , well, “short-sighted”…
Carl
Interesting discussion, as always, and by no means a “yawner.” The various pitfalls of both types of preneed funding need to be thoroughly examined so that practitioners understand the benefits of each. For instance, perhaps the most touted advantage of insurance is ….well, it IS insurance, and if the insured dies the policy will most likely pay off (assuming no contestiblity period, etc.). That is a huge benefit for their family.
The flip side, if I understand the actuarial tables* (and please correct me if this is wrong!), is that the probability of a 74 year old male dying in the next year is only 0.036519, with a life expectancy of another 11.21 years. If that is right, then the odds of benefiting from the insurance policy – in that way – are very very slim. In fact, most people are not going to die early, which stands to reason – if they did, the insurance companies would not be able to afford to offer the product.
The single-pay benefit you mention is very attractive, on it’s own merits. However, if a consumer is in a situation in which monthly payments are required, as are the majority of clients we see in our community, then the flexibilty of a trust-funded program may be an attractive option. With many consumers stapped financially, with depleted 401K savings, loss of job, reduced income, etc., we see the effects of our current broader economic landscape in the U.S. impacting our preneed operations.
With a trust program the funeral director can adjust the monthly payments to fit the exact requirements of the consumer: “I can only afford $80 per month.” “Okay, that will be fine, we can simply change your terms so you pay over 73 months.”
Since the trust vehicle doesn’t have the “cost of insurance” built in, the payments made by the consumer are likely to be less as well. Additionally, no one is turned away for health reasons, there are usually greater cancellation and refund options, and the flexibilty of most sellers can help a consumer experiencing a financial emergency.
One obvious problem for most sellers it that, in the event that their particular state laws require 100% trusting, they are faced with the need to either fund commissions out of pocket, or else go with insurance (assuming an active program with paid sales people). But it’s important to realize that, either way, there are no magic dollars materializing out of thin air and the consumer funds ALL slices of the pie, no matter how it is divided up. The question may then become, what is the best deal for the consumer? And once that is known, what is the best option for our business?
By the way, I enjoyed your last several articles dealing with commissions and sales force issues. Good job!
Brad Speaks
*Source: http://www.ssa.gov/oact/STATS/table4c6.html