A press release from A.M. Best that you can read here has revised the outlook to negative from stable for Funeral Directors Life Insurance Company of Abilene, Texas.

The rating change also states that the negative outlook reflects the company’s “ERM” or enterprise risk management.

The release also maintains that the company’s metrics “reflect the company’s generally steady operating earnings, driven by somewhat modestly growing preneed premiums.  A.M. Best does, however, view the company’s business profile as limited and concentrated in the preneed market.  They do point out that while preneed products are generally considered “lower risk”, those products have faced “challenges related to consumer trends of the last decade.”

Funeral Director Daily take:  We don’t know enough about the finances of FDLIC to really comment on the ratings or the company specifically.

We will, however, give our opinion on the last sentence from above where it mentions that preneed products have faced challenges related to consumer trends of the last decade.  I’m guessing that one of those trends is the increase in cremation dispositions.

If you think about preneed companies and the increasing and growing presence of cremation dispositions you don’t have a hard time understanding why credit ratings companies believe that the trend of increasing cremations will have a detrimental effect on preneed insurance companies.

Insurance is based on the law of large numbers.  In essence, over time, the law of averages will work out.  When it comes to insurance and premiums collected, out of those premiums must come claims expenses, sales expenses (including commissions), and the operating expenses of the company.  As money has been collected the insurance company also has a pot of money earning dividends and interest that it can also use to pay claims and operating expenses.

For the sake of our discussion, let’s just say all full-service traditional funerals cost $10,000 and all cremation services cost $4,000.  People generally pre-arrange for the amount they expect services to cost.

What is happening is that, as cremation grows, people are now, on average, pre-arranging closer to $4,000 rather than closer to $10,000 (from our example above) simply because more people are choosing cremation over traditional burial.  Generally, sales expenses and operating expenses are pretty fixed so, in essence, the margins of preneed companies are getting squeezed.  Add to that, that the “pot of money” available to invest for income and dividends is smaller simply because of lower premiums, and you can see more of the squeeze on the insurance company.

One bright side for preneed companies is the increasing interest rates from the Federal Reserve.  That is allowing their “pot of money” to earn higher income, but the rising interest rates do come with pressure, especially from salary increases, that may increase operating expenses.

It is our opinion that in order to build bigger margins we will see preneed insurance companies consolidate, in order to “right-size” corporate expenses,  or join larger insurance companies who do not have preneed arm much like happened with Great Western being acquired by American Enterprise Group earlier this year.

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