Assured return schemes: Rest `un'assured?

THERE are, at present, 25 assured return schemes with a total unit capital as on June 30, 2001 of Rs 27,420 crore. Of these, 16 schemes with an aggregate unit capital of Rs 17,814 crore mature at different dates within the next three years, five with an aggregate unit capital of Rs 4,667 crore and maturing between March 31, 2005 and February 28, 2006, have returns assured on a one-year basis and four with aggregate unit capital of Rs 4,939 crore are long-dated schemes that mature between September 2014 and June 2020.

As a result of decline in interest rates, tax on dividend distribution, a change in a part of the portfolio from debt to equity and returns offered on one-year schemes being higher than expected returns, there is a significant gap between the future liability and investible funds in respect of assured return schemes. Under SEBI regulations, this gap will have to be met either by the Sponsor or the AMC.

Potential gap: A major issue that needs to be resolved before any restructuring of UTI is the gap between the potential liability in respect of the assured income schemes and value of the available assets of the schemes.

A proper valuation can be made by an independent valuer of UTI as a whole, to determine whether there is a possible premium or shortfall after taking into account its goodwill, as also its contingent liabilities.

If there is a premium, it can be credited to the various schemes as considered appropriate. If, however, there is a shortfall, it will have to be provided for after considering the value of the Development Reserve Fund.

If this shortfall is not met by the holders of the initial capital of UTI and/or the Government, there would be no option but to reduce the benefit under each assured return scheme in an appropriate manner. This could again result in litigation and also further loss of confidence in UTI.

Behind the shortfall: The present and future liabilities under the assured return schemes have significantly increased for a number of reasons:

* First, there has been a general decline in interest rates and consequent decline in earnings of the schemes.

* Second, effective from April 1, 1999 dividend distributions by the schemes have been subjected to a tax to be borne by UTI, and cannot be passed on to the unitholders under the schemes.

* Third, there has been a progressive shift from debt to equity in the asset portfolio of the schemes, both as a result of secondary market operations and inter-scheme transfers, within the overall limits prescribed in the offer documents of the schemes, that have had an impact on current earnings.

* Finally, even in respect of schemes where returns are assured only on a 'one-year' basis, assured returns announced at the beginning of each year, have often been higher than the returns that can reasonably be expected to be earned during that year.

* The situation is further compounded by the fact that, as a result of the melt-down in the stock market, the market values of the assets of the schemes have significantly declined.

* As a consequence of these factors, there is already a significant gap between the liability under the schemes, and the market value of the available assets, under the schemes and this gap will grow at alarming rates in the future.

Reduce the shortfall: It is necessary to make provision for the contingent liability in respect of assured return schemes. To reduce the gap between the present value of the future liability and the value of assets under the schemes, the following steps should be taken:

* The portfolio of the schemes should be recast to convert investment in equity into investment in Government securities, and debt instruments.

* It may be possible to slightly narrow the gap if part of the investments is made, not in government securities but in corporate bonds rated `AAA' so as to fetch a higher return than on Government securities. This is a matter that may be left to the proposed AMC.

* The gap has widened in the last few months because of the decline in the market values of the scheme's assets. It may, therefore, be necessary to wait for a while before the conversion from equity to Government securities is effected.

* In respect of `one-year' assured return schemes, the practice has been to declare assured returns in line with earlier declarations though the current earning rates may have declined. If the assured returns are restricted to the scheme's expected earning capacity, the gap can be further reduced.

* The schemes are presently subject to a tax of 10.20 per cent under Section 115R on dividend distribution. This tax was not envisaged when the schemes were floated, and it is not possible to adjust the guaranteed returns on the schemes for this unanticipated levy.

However, as part of this tax, the dividend on the schemes has become tax-free under Section 10(33) which also was not anticipated. It would, therefore, be fair to amend the Income-Tax Act to provide that dividends paid under guaranteed return schemes floated before the dividends were made tax-free, will continue to be taxable, and that no dividend tax will be levied on such schemes. If this amendment is made, the gap can be further reduced. The I-T Act should be amended to provide that in respect of assured return schemes floated before June 1, 1999, dividends are not exempt under Section 10(33), and no tax is levied on the schemes under Section 115R.

* The Development Reserve Fund should be transferred, free of consideration, to the AMC after valuing the Fund's investments of the Fund at their fair market value.

* However, even if these recommendations are implemented, a substantial gap is likely to remain. The balance in the Development Reserve Fund as on June, 2001 is Rs 1,535 crore and the current annual contribution by the schemes is around Rs 120 crore. Even if these contributions continue till the last of the assured return schemes matures in 2020, the Fund may be able to bridge only a part of the gap.

SEBI regulation on shortfall: SEBI regulations provide that in respect of assured return schemes, the responsibility for meeting the shortfall, if any, will fall on the Sponsor or the AMC. It is difficult to make an accurate assessment of this future liability, since it would depend on a number of factors such as future rates of earnings, the composition of the portfolio, the continuance of, and rate of, dividend tax, the future pattern of redemption, and so on.

Edited extracts from the Report of the UTI Corporate Repositioning Committee headed Mr Malegam.