A Preneed Prognosis
Life is not exactly like it was a short time ago. The stock market was recently at its lowest point in almost 12 years. Institutions that were rock-solid no longer exist. The entire banking sector is in trouble. Unemployment is a nationwide problem. And you don’t even want to think about what is going on in the housing market. It has been a long time since our economy has been stressed the way it is being stressed today. Everything is changing. Energy prices are still high. The cost of food is escalating. Our nation of consumers will be changing habits as the slowdown continues. Things that we viewed as empirical truths turned out to be no more than myths. Many of the ideas we believed and held dear are no longer valid. It’s the perfect time to question a lot of the assumptions we have made over the years. It is a great time to step back and ask yourself if a preneed program still makes sense for your firm.
Every business has a certain amount of risk associated with it. Most of the risk is manageable and within your control. You make calculations to decide how much risk you are willing to take. Generally speaking, the greater the risk you take, the higher the reward. Likewise, the greater the risk you take, the higher the likelihood of failure. Think about your personal investments for a moment. If you were risk-adverse you would have had a portfolio of fixed income securities and stayed away from stocks or mutual funds associated with stocks. When the market crashed you would have been in much better shape than the individuals who had their funds invested in the stock market. Now think about your business. For example, you have an insurance policy on your funeral home. You likely had a choice regarding how large a deductible you wanted to have on the policy. The more risk you were willing to bear (higher deductible), the lower your premium on your policy. You either consciously or unconsciously made an event occurring and chose the deductable based on what you believed was the right combination of risk and reward. If you have a preneed program today you have made some choices about the risk you are willing to take. For example, you have a choice where you invest your preneed funds. Some of you chose to use investment vehicles associated with the stock market. You did extremely well for quite some time, but when the market crashed you likely suffered significant losses. You made a decision about the risk you were willing to assume. Others chose to use insurance companies as the funding vehicle. Insurance companies are highly regulated in terms of where they can invest policyholder funds. They have very conservative investment policies. While they might not be paying high rates of interest on your preneed policies right now, they are also not losing 40 percent of their value. Given their conservative nature, you are taking a greater risk of a preneed shortfall when using insurance. Risk and reward tend to go hand in hand. So which is the right choice? In my opinion, neither choice is wrong as long as it is made while aware of the risk factors of each. Guaranteeing a funeral at today’s prices is without a doubt a risk with any preneed program. Without the guarantee there is little reason for a consumer to deposit their funds in advance with the funeral home, other than for spend down purposes. To determine whether or not you should continue with an active preneed program, logic dictates doing a risk assessment. There are two major components of risk that jump out at you immediately. The first is if a firm’s increase in cost over the time horizon will exceed the increase in value of the preneed funds dedicated to the service. The second risk is if the organization you trust your preneed funds to will be in business when the contract comes due. Over the years there have been an incredible number of schemes for funding preneed contracts. The sage advice, if it sounds too good to be true it probably is, would be good advice to follow. This risk can be mitigated by choosing a company that is dedicated to this business and understands the needs of the funeral directors- the need to have the money there when the service is performed. You and your families’ funds should be invested conservatively and safely. To do otherwise does not seem prudent and is inconsistent with the values of the funeral service industry. This gives rise to the other part of the risk you worry about: shortfalls. It’s always nice when the value of your preneed funds meets or exceeds the current cost, based on your price list, for the funeral you are about to perform. Unfortunately, that does not always turn out to be the case. As a business owner you feel like you are giving away profits that would be there if you had not guaranteed the price of the funeral. This is true if the family would have purchased the exact same service from your firm at the time of need. Do you know for sure they would have? Are you better off taking the risk of losing the family or having the family choose a different type of service? From my prospective, some of them were just wrong and filled with bad information, and some of them were written in light of the horrible deterioration of trust funds invested in the stock market. I have yet to read an article that makes an accurate financial assessment of the shortfall situation. I am not trying to preach to anyone here; all I want to do is to provide you with one more tool to assess the risk of the guarantee. Every business has costs. You can look at cost from different perspectives. You have direct cost, and you have allocated cost. You also have fixed cost, and you have variable cost. Your fixed costs are somewhere between 65 to 70 percent of your total cost. They are going to be there no matter what you do. Your variable costs make up the difference. So if your average funeral is $6,500, your variable cost is somewhere between $1,950 and $2,600. As long as you receive that amount, it makes financial sense to perform the funeral. That’s an extreme example, so let’s look at one that is more likely to occur. Say you preneed a funeral today for $6,500. You fund it with an insurance policy that pays 2.5 percent compound growth. You perform the funeral seven years in the future. Your policy value is $7,726. Your costs over the same seven- year period have grown at a 4 percent compounded rate. If you were to write the same contract at the time of performing the funeral you would ask the family for $8,553, creating a shortfall of $827. On the other hand, you can also say that only 35 percent of my costs were variable, and by performing that funeral a contribution of $4,732 was made to cover the fixed cost. As a business person whose objective is to maximize profit, you should take every funeral you can that makes a contribution to fixed cost. The only way that does not make sense is if you have no excess capacity. If you have so much business you can’t perform one more funeral, then you should say no. it is more important to note that I am stressing maximizing profit, not profit margin. Stay focused on the $4,732 contribution margin as we discuss the other risk because that number is the number I believe you should use to make your risk management.
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