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Trust: The Present Need of Pre-Need Companies

(Article published in the Feb 10,2003 issue of TODAY, Business Section)

For estate planners and practitioners in the trust industry, a major highlight of this year’s Pre-Need Consciousness Week from February 1 to 7 was the discussion of the notion of "Trust Fund Variance" during the industry forum held in the afternoon of February 6 at Makati Shangri-la Hotel, Makati City. Securities and Exchange Chairman Lilia Bautista gave the principal exposition; Juan Miguel M. Vazquez, President of the Philippine Federation of Pre-Need Companies, Inc. provided the pre-need industry’s reaction.

The trust fund required by the SEC Preneed Rules to be set up for every type of preneed plan that preneed companies offer to the public plays such a central role in the ability of the preneed industry to deliver on its promises that considerable serious attention has been recently focused on the question of whether present and future plan holders really have something to look forward to in the future. The selling point of a pre-need plan is the promise to the plan holder of adequate funding with which to pay for his future expenses when they have to paid. The trust fund is the primary mechanism by which the industry assures its clientele that the promise will be kept.

The total of the trust funds set up by the preneed industry has apparently reached critical mass, enough to send trust entities to compete with one another for the management and administration of the fund’s assets. Vazquez reports that as July 2002, the industry trust fund amounted to P44 billion and, not too humbly notes that P13 billion is lent to the Philippine government. No wonder, therefore, that the SEC, the regulatory agency presently charged with supervising the pre-need companies, is looking at the state of the industry’s trust fund with an extremely meticulous eye.
 










Annually, at the end of the fiscal year of a preneed company, the SEC requires a valuation of the company’s promised benefits and compares it with the trust funds set up for each of its plans. The promised benefits are in reality legal obligations of the pre-need company that, prudence requires, ought to be met by property set aside or reserved by the pre-need company for that purpose, and the process of determining how much that should be is the province of that elite group of professionals called actuaries; hence, the shorthand term "actuarial reserve liability" or ARL. The ideal is that the trust fund is always equal to the ARL. But if the trust fund is greater, then is said that there is an excess or positive trust fund variance; if lesser, then there is a negative variance or a deficit.

Unlike our finance officials who have come to terms with it by describing it as "manageable" or "under control" or, in less critical times, "tolerable", Mike Vazquez winces at the word "deficit". It sows terror, according to him, in the hearts of people, making them think of bankruptcy and business failure. The pre-need customers (in the last eight years, the industry generated over 4.3 million new clients) are led to worry about the future; the labor and sales force (they numbered in 2001 over 200,000 in employees and licensed agents) lose their confidence in their careers; the companies themselves lose face; and, alas and alack, the regulator is unjustly seen as incompetent and corrupt to have let it happen. I myself am sufficiently terrorized by Vazquez’s depiction of the doomsday resulting from the use of the word "deficit" -- George Bush’s extrapolation of the consequence of Iran’s having weapon’s of mass destruction pales in comparison--so, I will confine myself to "negative variance".

Once a negative variance is detected, the preneed company is required to take remedial measure, essentially by putting in more of its assets in the trust fund, and, if that be insufficient, by asking the stockholders to infuse additional capital. Everything should therefore go well. That is, however, as pointed out by chairman Bautista, "if everyone complies with the rules".

But, actually, even if everyone were to comply with the rules, and the ARL and the Trust Fund were kept continually in equilibrium by all the industry players, there is no absolute certainty that the promises of the pre-need company will be kept for any one specific holder. The vulnerability of a pre-need plan comes both from the side of the ARL, which is recorded in the liability portion of a pre-need company’s balance sheet, and from the side of the trust fund, which is reported in the asset side.

Chairman Bautista candidly discloses that while "the ARL is the best estimate of the am04ount of assets in a trust fund that a pre-need company is required to set up with a trustee", it is still "an estimate’, albeit the best. The actuaries look into the future with bleary eyes, their extrapolations dependent on, among other items, assumptions and historical data as well as valuation formula, abstractly precise and concretely fallible.

Among the critical assumptions are the interest rate, by regulation referenced to the longest term government securities in the market issued or traded for the last three years, rate of increase of the costs of the benefits promised, and, the termination rate, a pleasantly neutral term used to describe the rate that the plan holders give up on their plans and cease paying. Add to this the absolute necessity that the pre-need company must maintain and make available to the actuary a complete and accurate database of all in force and active contracts and other pertinent information and the need to understand the valuation formula, for the layman, becomes a superfluity.

Last year, the SEC issued three circulars to provide actuaries with guidelines in coming up with reasonable and attainable assumptions and safeguard the integrity of the valuation of reserves, but still, at the end of the day, the ARL is an estimate. The actuary is, of course, more reliable than the Delphic oracle, but still, not a divine prophet.

The trust fund, similarly, is vulnerable . Though insulated from the pre-need company, required to adhere to investments guidelines and limits –more about that in a later column—, and supervised by the Bangko Sentral ng Pilipinas, the trust entity managing the preneed company’s trust fund is not an insurer of the plan holder’s benefits. The trustee does not and cannot, under the law and regulations, guarantee its performance nor its delivery of the required amounts at the states times.

So, where does that leave the plan holder? All told, despite all the statutory and regulatory safeguards, some already in place and others still be enforced, the plan holder has to put his trust in the company he is dealing with and in the people running it. Due diligence requires that he carefully choose the firm he selling him a plan, check its past performance (though that it not necessarily an guarantee of what it will do in the future), conduct lifestyle inquiries on its executives and owners, examine its reports and financial statements as well as disclosures made the SEC, investigate its business ethics and practices. Having a pre-need plan does not make the plan holder need-free. Because he is parting with his money now, for a promise in the future, he should all the more be vigilant and militant in protecting his interests. After all, the need he is providing for, when it does come, will still be his need.

    

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