Hard to Value Assets and Pension Funding

Add wine and cheese to the picnic basket and the pension fund too. According to "Companies Substitute Tangibles, Like Cheese, for Investments" by Mary Williams Walsh (New York Times, April 19, 2013), gaps in funding status are tempting some sponsors to add "unusual assets" to their portfolio. Her list of in-kind contributions includes cheese, whiskey, water rights, precious stones, oil wells, a restaurant, a brewery and a slaughterhouse.

An obvious advantage to a plan sponsor is the preservation of cash when an intangible or tangible asset is instead contributed. Another benefit is the potential upside associated with an asset poised for capital growth. This is especially true if cash contributions would be parked in a low-interest rate security or fund.

The downside is that an expectation of higher returns almost always means a greater uncertainty of realization.

Requisite approval by the U.S. Department of Labor may or may not mandate the hiring of an independent fiduciary to in turn engage someone to assess the value of an intended in-kind contribution. As a trained appraiser, I would tell anyone who asks that there are multiple items that must be assessed as a precursor to determining fair market value of the asset in question. Some of the items are listed below. This is not an exhaustive tally by any means.

1. Control - If there are multiple owners of an asset, it is important to assess the extent to which the ERISA plan can exercise authority over how an asset is used, disposed of and/or managed for purposes of adding to the asset's value.
2. Priority of Economic Claims: Understand whether the pension fund will be first in line to receive cash from the service and/or subsequent sale of the item being considered for contribution.
3. Collateral: If the value of the intended in-kind contribution item is supposedly dependent on other assets, it is critical to know whether that collateral is fungible and if there are sufficient assets in place.
4. Customer Diversification: If all or part of an operating business will be contributed to an ERISA plan, someone must make sure that revenue is generated from a sufficiently large number of clients so that if one or more large customers disappear, the value of the asset being contributed will not be adversely diminished.
5. Marketability: Not all assets trade in an active secondary venue. Discounts for lack of marketability need to be carefully examined so that the ERISA plan does not overpay.
6. Legal Protection: The appraiser must know whether an item such as a trademark or patent or other type of intangible or tangible asset is protected under law in terms of ownership and/or restricted use.
7. Quality of Management: If the pension fiduciaries are tasked with running a business or maximizing the value of an intellectual property asset to be contributed to a plan but do not have the time or requisite knowledge, someone may cry foul if the item loses value.
8. Maintenance: The value of an asset such as real estate, a building or piece of heavy equipment will go down if not cared for in a timely fashion. The cost of upkeep and/or the speed of obsolescence are two of many considerations that cannot be ignored. If an asset requires significant cash to keep it in tip top shape, it could be a drain on scarce pension plan resources.

Besides the valuation-related issues, an objective third party needs to assess the prudence of including a particular asset in the plan's portfolio. Then there is the issue of how the intended in-kind contribution will impact regulatory reporting, financial statement representation and actuarial requirements, not to mention future cash inflows and outflows.

The decision to contribute an in-kind asset is far from trivial. Like any other decision for an ERISA plan, care and diligence must be demonstrated before taking action.

Source: http://feeds.lexblog.com/~r/PensionRiskMatters/~3/uXTrTDJ7x18/

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