Six funeral homes are suing the Illinois Funeral Directors Association, accusing it of coordinating a Ponzi scheme built on life insurance policies

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Funeral fund is focus of lawsuit alleging Ponzi scheme


By BRUCE RUSHTON
THE STATE JOURNAL-REGISTER
Posted Jan 31, 2009 @ 11:30 PM
Six funeral homes are suing the Illinois Funeral Directors Association, accusing it of coordinating a Ponzi scheme built on life insurance policies.

In the legal action, akin to a shareholders’ suit in the corporate world, the funeral homes say they’re on the hook for potentially tens of millions of dollars in funeral costs because a pre-need funeral trust fund administered by IFDA Services, a for-profit arm of the non-profit IFDA, has been bleeding money. The fund is supposed to pay for funerals for an estimated 49,000 people in Illinois who took out pre-need policies.

The IFDA should never have been in the trust business in the first place, the state comptroller’s office has ruled. The IFDA trust got its start thanks to a license issued in 1980 by then-state Comptroller Roland Burris, who went on to become an IFDA lobbyist and ultimately a U.S. senator.

In the lawsuit, filed Wednesday in Sangamon County Circuit Court, the group of funeral directors says IFDA Services promised that trust money was being invested in U.S. Treasury securities, corporate bonds, certificates of deposit and other “quality, fixed-income securities.”

Instead, the bulk of the money — more than $190 million, according to the lawsuit — was used to pay for life insurance policies on funeral home directors and IFDA insiders. However, those folks aren’t dying fast enough to pay the bills, the plaintiffs say, and even when an insured person dies, returns aren’t guaranteed.

Fund written down 25 percent

Last fall, the fund, believed to total about $300 million, was written down by 25 percent to address a $59 million deficit. To prevent a run on the fund, the state last summer barred funeral directors from withdrawing what money is left except to pay for funerals.

John Duggan, an Aurora attorney who is seeking class-action status for a second lawsuit against the IFDA, filed on behalf of two women who bought pre-need funeral contracts, said the average life expectancy of people who buy pre-need funeral contracts is less than 10 years. But the life expectancy of the insured funeral home directors and IFDA insiders was 20 years when the policies were purchased. In their lawsuit, funeral home directors say the insured funeral directors and IFDA officials’ average age is the mid-60s.

“They were paying Beneficiary A’s benefits with Beneficiary B’s contributions,” said Duggan, whose lawsuit mirrors the one filed in Sangamon County. “That’s a classic Ponzi scheme.”

In a written statement, the IFDA said it was acting on recommendations of financial advisers. In a separate written statement, IFDA president Jim Bosma blamed excessive interest payments to funeral home directors and losses in financial markets for the fund’s depletion.

“We are hopeful that a plan can be fashioned to restore earnings to funeral directors over the long term,” Bosma wrote.

But Terry Plummer, a Litchfield funeral home director who has been pressuring the IFDA to provide a full financial accounting to its members, says greed, not downturns in financial markets, created the mess. At one point, he said, the fund was losing $25,000 per day. Plummer says the fund has been written down an additional 9 percent for a total loss in value of 34 percent.

“It’s self-inflicted,” Plummer said. “All this damage has been done from within.”

The financial crisis has not been without light moments. During a convention last year, funeral home directors, knowing that life-insurance payouts would swell the trust fund, used laser pointers to cast red dots on the hearts and heads of colleagues covered by the fund’s insurance policies. But the stakes are high. Duggan and other IFDA critics predict some smaller funeral homes could be driven out of business.

Six-figure losses

Some funeral homes already have had to pay for funerals that were supposed to have been covered by the fund, according to plaintiffs in the Sangamon County lawsuit. State Sen. Deanna Demuzio, D-Carlinville, who has met with funeral home directors, said some homes have absorbed losses rising into the six figures.

“When you have a small funeral home, that’s a huge amount of loss,” Demuzio said.

Besides the IFDA and IFDA Services, defendants in the Sangamon County lawsuit include past and present IFDA board members, former executive directors, the association’s lawyer, Merrill Lynch and a Merrill Lynch financial adviser who sold life insurance policies to the IFDA.

The IFDA says using life insurance to fund funeral trusts is common practice in the funeral industry.

Not so, says David Nixon, a Chatham funeral home consultant who’s spent 30 years giving business advice to funeral home operators.

“I don’t know of anyone else who does it,” Nixon said. “Tell them to give you a list.”

Nixon said he believes every point raised by the group of funeral home directors in their lawsuit is valid. He blames the financial crisis on everyone from Burris to defendants in the lawsuit to state Comptroller Dan Hynes, who was in office when red ink started spilling in 2001.

Hynes revoked the IFDA’s license to run the trust in September 2007, but he should have acted sooner, Nixon says. Instead, Nixon contends, the comptroller’s office and the IFDA dealt with the crisis quietly until it was too big to ignore.

“It’s a scary thing here,” Nixon said. “They were fearful there was going to be a run on the trust and that consumers would panic.”

The comptroller’s office sent the IFDA a letter on June 21, 2006, notifying the association that two audits had shown a $39 million deficit in the trust and $8.6 million in excessive management fees paid to IFDA Services.

“This is an intolerable situation that IFDA must rectify,” wrote Percy Lucina, director of the comptroller’s cemetery care and burial trust division.

License revoked

The comptroller revoked IFDA’s license 18 months later, saying it was void from the beginning.

“That means it shouldn’t have been issued to begin with,” said Carol Knowles, Hynes’ spokeswoman, adding that the comptroller acted as quickly and forcefully as he could.

According to the lawsuit, the comptroller’s office had authority to license funeral homes that sold pre-need funeral contracts to the public but not to license overseers of trusts.

Burris was comptroller in 1980 when his office authorized the IFDA to manage the funeral trust. After leaving elected office in 1995, Burris became a lobbyist for the IFDA, which had been a campaign contributor.

A message left Friday on Burris’ Senate office answering machine was not returned.

Funeral directors say they didn’t know the trust was in trouble until the IFDA lost its license, and even then, association officials told funeral directors not to worry. In a letter sent shortly after the license revocation, IFDA officials said, “there is no need for concern. All the funds that Illinois funeral homes and their clients have placed into the IFDA trust have been safely invested, and all of the money is accounted for.”

Less than four months later, IFDA officials sent a memo to funeral home directors acknowledging a deficit in the fund, but insisting that the insurance policies had “considerable value and importance.” But Regions Morgan Keenan Trust, a Tennessee investment firm retained by the IFDA to administer the fund in early 2008, was wary, according to the plaintiffs. The firm backed out of the plan to manage the trust, saying the life insurance policies would have to be liquidated before the company would agree to administer the fund, the plaintiffs say.

With no licensed investment firm at the trust’s helm and IFDA Services stripped of its license, the state Department of Financial and Professional Regulation in May sent a cease-and-desist order to IFDA Services, ordering it to stop running a trust business and billing itself as a fiduciary. That order led to Merrill Lynch Bank and Trust Co. taking over as trustee.

‘Millions in commissions’

Merrill Lynch, Pierce, Fenner & Smith, the investment arm of Merrill Lynch, is a defendant in the funeral directors’ lawsuit, as is Edward Schainker, a Merrill Lynch financial adviser who sold 120 life insurance policies to the IFDA trust fund and collected “significant” commissions, according to the plaintiffs.

“Schainker is the guy they’re (plaintiffs are) going after,” Plummer said. “The guy made millions in commissions off these trusts.”

Schainker declined comment, according to a woman who answered the phone at his Springfield office. Bill Halldin, a Merrill Lynch spokesman based in California, said he had no response to questions about sales commissions and whether life insurance is an appropriate investment tool for a tax-exempt funeral trust.

IFDA officials refused an interview request. In an e-mail sent in response to written questions, the IFDA also refused to say how much was paid in commissions, saying such information is proprietary. The e-mail does not say who wrote it.

The objecting funeral directors say life insurance is a lousy way to invest trust money. For one thing, policies can’t be traded or borrowed against, nor can money be withdrawn from policies without hefty tax penalties. In addition, the policies sold by Schainker don’t pay fixed benefits upon death, plaintiffs say. Instead, the policies pay out based on the performance of investments made with premium monies.

An economic downturn could lower the value of investments made with premium money, Duggan said, but even without a down market, the trust fund was bound to implode because the life expectancies of the insured didn’t match the life expectancies of people who bought funeral contracts. Rather than pay for insurance policies on funeral home directors who might or might not die when the money is needed, consumers would have been better off buying life insurance policies on themselves to guarantee that money would be available upon their deaths, he said.

“I guess the only way this trust would break even is if all these guys (the people insured by the life insurance policies) simultaneously died,” Duggan said. “It was not actuarially possible for these investments to perform.

“The question is, what were they intended to do except generate commissions?”

In its e-mailed response to questions from The State Journal-Register, the IFDA said it acted on the advice of unnamed financial advisers when it purchased policies beginning in 1986. The IFDA stopped buying policies in 1999, according to the response.

The IFDA paid interest to funeral home directors without regard to the fund’s performance, according to the lawsuit, leading directors to conclude that the fund was solvent.

‘Much like a Ponzi scheme’

“Plaintiffs and participants in the pre-need trust program were led to believe, falsely, that the pre-need trust was performing well and as expected, when it was not,” the plaintiffs say in their lawsuit. “Much like a Ponzi scheme and the escapades of Bernard Madoff, IFDA Services had been paying interest rates well above actual earnings for years, taking new deposits to pay returns to, and death claims of, pre-existing pre-need funeral planning customers.”

Plummer said IFDA officials have refused repeated demands by funeral directors to open the trust fund’s books. In its written response to questions, the IFDA says it has “completely opened its books” and worked closely with state regulators.

But Knowles, the comptroller’s spokeswoman, said the IFDA didn’t want to hear what regulators were saying.

“The leadership of the IFDA was very resistant to trying to resolve the issues that we raised,” Knowles said.

Ed Wallace, a Chicago attorney who is representing the plaintiff funeral home directors, said the exact size of the fund and where money went still isn’t known.

“One of the things we’ve asked for is an exact accounting,” Wallace said.

Bruce Rushton can be reached at 788-1542.