Well this is a fun expression and I beleive a true Malcolmism - I've never heard anyone else ever use it, let alone understand it. My Explanation is as follows - Malcolm often uses it to describe scary looking people, with the gist being that a funeral is a fairly scary thing in and of itself, so that if a Funeral was willing to cower down an alley from something, that thing must be quite horrific.
I'm almost positive that the intention of this expression was to describe how scary looking someone was by using the association with a Funeral / Death - but as I think about it more, I did get Three hours of Sleep last night, could it also be used to say that there are worse things than death, the one that comes to mind is not living your life - because at the end of it all I hope that you could look back at all the things that you've done, all the Places you've been and all the people that your life has touched and pass away with a smile on your face. A life well lived is it's own reward.
One more thought on Scary People - They are only scary looking if you don't get to know them, because after you know them, looks matter less and personality matters more. The ones that you really have to watch out for are the ones that look good but are scary on the inside, then it's really time to head up that alley...
On a completely unrelated topic - My wonderful Sister had a birthday yesterday - she sure makes me smile and she is living her life to the fullest - Happy B-Day Megs