| Tue 4 Sep 2007, 11:00 | | DSY - Discovery Holdings Limited - Audited results |
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DSY
DSY
DSY - Discovery Holdings Limited - Audited results for the year ended 30 June
2007
Discovery Holdings Limited
(Incorporated in the Republic of South Africa)
(Registration number: 1999/007789/06)
JSE share code: DSY
ISIN: ZAE000022331
AUDITED RESULTS FOR THE YEAR ENDED 30 JUNE 2007
- Diluted HEPS +33% to 168,4 cents per share
- New business annualised premium income +15% to R5,2 billion
- Total dividend for the year of 37 cents per share
- Operating profit +20% to R1,5 billion
- Net profit after tax excluding BEE +34% to R1,1 billion
IntroductionThe period under review has been not only a successful period,
but also a fundamental one in the evolution of Discovery. Operating
performance has progressed in a pleasing manner, but more importantly,
significant structural change has taken place - both at shareholder level and
within most of the operating businesses. The unbundling of FirstRand`s
shareholding in Discovery is a point of inflection for Discovery, in that it
removes any strategic conflict going forward and opens up many opportunities
for the group. Within each business, significant innovations took place
during the period. Not only does innovation continue, but additional
businesses have been constructed and will be rolled out during this present
financial year. The combination of these factors has created a step-change
within Discovery and in its prospects. It is important to note that
Discovery`s purpose of making people healthier and enhancing and protecting
their lives fits in squarely with the global trend of wellness. Discovery
finds itself, within each of its businesses, able to compete effectively and
sustainably - and able to meet clients` needs in unique ways. The Discovery
ethos of "consumer-engaged financial services" flows through all of the
businesses, creating consumer demand for our products, ensuring strong
organic growth and driving profitability for shareholders.For the period
under review group operating profit increased by 20% before the impact of the
BEE transaction to R1 510 million (2006: R1 263 million), while net profit
after tax, excluding BEE, rose by 34% to R1 107 million (2006: R827 million).
Diluted headline earnings per share before the impact of the BEE transaction
increased 33% to 168.4 cents (2006: 126.4 cents) and new business grew to
R5.2 billion.The unbundling of FirstRand shareholding in DiscoveryDiscovery
is pleased to announce that FirstRand will be unbundling its majority
Discovery shareholding to FirstRand shareholders. Over the past few years
there has been regular debate at the FirstRand and Discovery Boards regarding
FirstRand`s majority shareholding in Discovery, including the relative merits
of an unbundling:From Discovery`s perspective, there has been a continuous
trade-off between the considerable value added by FirstRand against the
market-place competition between Discovery and other FirstRand companies - in
particular, Momentum. In the past, such tensions have been managed
particularly well. However, Discovery`s growth, both in size and in scope,
will invariably lead to difficulties going forward. With Discovery`s
impending launch of its investment business, the potential for conflict has
increased.From FirstRand`s perspective, its strategy of owning two insurance
companies within the Group, balancing growth in market share with increasing
levels of competition, was consistently monitored to ensure shareholder value
was maximised. For both FirstRand and Discovery, it is clear that the
strategy has worked in the past to the benefit of all shareholders. However,
going forward, the benefits of an unbundling are significant, and reflect the
positioning and scale of both Discovery and FirstRand. Discovery is
particularly pleased with this development, for the following reasons: The
unbundling removes any strategic conflict and provides Discovery with
flexibility and increased scope for business opportunitiesWithin its new
shareholder base, RMBH becomes Discovery`s strategic capital partner. It is
important to point out that RMBH was the original shareholder of Discovery
and in effect - from a philosophical point of view - Discovery is now
returning to the shareholder structure it had when it was formed in 1992.
The unbundling creates a significant opportunity to further enhance
management ownership. Key members of the management team have indicated their
intention to increase their shareholding following the unbundlingThe
unbundling addresses the long-standing issue of Discovery`s small free-float
and limited liquidity of shares. When combined, the current shareholdings in
Discovery of FirstRand, Discovery management and Discovery`s BEE partners
totals 82%, leaving a free-float of just 18%. Discovery HealthDiscovery
Health`s performance over the period was particularly pleasing. In addition
to its focus on providing access to quality care on a sustainable basis for
its clients, key structural initiatives were undertaken over the period aimed
at placing Discovery Health and the schemes it manages in an advantageous
position. Operating profits rose by 12% to R736 million (2006: R655 million),
with new business improving to R2 577 million
(2006: R2 505 million). The number of lives under management grew to 2 025
650 in total (2006: 1 939 339). Discovery Health`s strategy is to utilise its
scale and sophistication to build a better healthcare system for
stakeholders. In this regard, a central initiative during the period was to
interface with hospitals, doctors and other providers of healthcare in order
to ensure quality and cost-effectiveness within the healthcare system. To
this end, Discovery Health embarked on a process with doctors to increase
their remuneration appropriately and ensure that members have access to care
without gaps in their coverage. The roll-out of the GP Network and the
Premier Rate payment mechanism for specialists are two central strategies in
this regard. This has proven particularly difficult and has ignited
considerable debate within the medical community. The debate has highlighted
the historic chasm that exists between providers and funders of healthcare.
Nonetheless, significant progress is being made with the South African
Medical Association (SAMA) and many of the specialist societies now endorsing
the need to work with Discovery Health in order to build a system that is
sustainable for both members and health professionals. Discovery Health is
optimistic that significant progress has been made to date and expects this
to continue.From a structural perspective, considerable focus was placed on
maximising operating efficiencies. In addition, Discovery Health`s
administration fees were reduced by approximately 1% of Gross Contribution
Income, translating to a reduction of R145 million in income for Discovery
Health.In addition, considerable progress was made in building up the
statutory reserves within the Discovery Health Medical Scheme towards the
required level of 25% of Gross Contribution Income, as laid down by the
Medical Schemes Act. Given the size and growth of the Discovery Health
Medical Scheme, the Council for Medical Schemes requires it to reach 23% by
31 December 2007 and 25% by 31 December 2008. Both Discovery Health and the
Discovery Health Medical Scheme are confident of achieving these targets as
set out by the Regulator.The combination of these factors positions Discovery
Health particularly well going forward. Discovery LifeDiscovery Life`s
performance exceeded expectation. In addition to performing particularly well
in the pure life assurance (protection) market, considerable progress was
made in the construction of its long-term investment business - due to be
launched during October 2007. The company increased operating profits by 29%,
while gross inflows under management increased by 33% to R2 357 million
(2006: R1 768 million). Annualised new business premium income rose by 23%,
to a record of just under R1 billion (2006: 789 million). The value of
business in force improved significantly, growing by 35% to R5 826 million
(2006: R 4 322 million).The company has developed a strong leadership
position in the pure-risk life insurance market (protection market), enabling
it to grow both strongly and profitably. In addition, the strong growths in
embedded value - and the positive experience variances within it - reflect
the quality of business being transacted.During this period, focus was
applied to Discovery Life`s distribution channels to enhance and deepen their
potential - for both the existing protection products and the impending
investment products. To this end, work began on the construction of a high-
quality tied agency force. By the end of the period almost 100 agents with
production significantly above market average have been recruited, and are
currently producing approximately 10% of Discovery Life`s new business.
Discovery Life`s launch into the investment market is aimed at capitalising
on current market trends and the macro factors giving rise to them. The
approach will be to embrace the evolving trends in the investment markets of
consumerism, transparency of fees and open architecture, with Discovery`s
ability to add value through product innovation and its other assets.
Discovery Life is confident of its ability to make an impact in this market
and to add value to its clients.PruHealthPruHealth`s performance over the
period was in line with expectation. Discovery remains optimistic in its
potential for profitable growth and its ability to make an impact on the UK
market. During the period, focus was applied to pricing, underwriting and
managed care, in order to maximise the quality of business, and to building
the infrastructure to ensure that it can achieve cost levels that move it
toward profitability. Importantly, focus was applied during the period toward
the construction of PruProtect - the pure life insurance joint venture
between Discovery and the Prudential, which will be launched on
25 September 2007.New business grew strongly to R743 million in annualised
premium income (2006: R282 million), bringing to 117 000 the number of lives
covered (2006: 58 912) by the end of the period. Operating losses increased
in line with our expectations by 23% to
?16 million (2006: ?13 million).While operating performance was largely in
line with that budgeted, new business production, although significant in
absolute terms, was behind target by the end of the period for the following
reasons:As part of the focus on optimising the balance between value and
volume, the direct-to-consumer strategy was revised during the fourth
quarter, along with the concomitant reduction of activity in this channel.
This resulted in a slow-down of new business for the quarter.On a similar
line and given the company`s scale and increasing credibility, it was felt
that a more disciplined approach to pricing large corporate business was
justified, resulting in a temporary lack of competitiveness.Both of these
factors have been addressed and new business has since reverted to budgeted
levels. Given the company`s scale, the infrastructure built and the focus on
cost and quality, it is expected that operating losses will narrow
significantly during the next financial year. During the period, ten broker
franchises were built and rolled out across the UK. These franchises will not
only provide broader access to brokers active in the health insurance market,
but will form a crucial distribution channel for PruProtect as it rolls out
from September onwards. In preparation for the launch of PruProtect, the
corporate structure of the entire joint venture with Prudential has been
reworked. Going forward, Discovery and the Prudential plc will each own 50%
of PruProtection, the holding company of PruHealth and PruProtect.Discovery
remains optimistic about the prospects for PruProtection.Vitality and the
DiscoveryCardVitality`s performance over the period was ahead of expectation.
Revenues increased to R721 million (2006: R654 million) and operating profits
remained flat at R43 million (2006: R41 million).Vitality is the
manifestation of Discovery`s vision of making people healthier and, to this
end, its primary role is to underpin and to integrate Discovery`s products so
that they offer added value to Discovery`s clients. During the period,
Vitality performed its crucial role of creating a significant impact on
profitability, product competitiveness and reduced lapses across the Group.
In particular, the Discovery Life Card Integrator was launched during the
period, bringing together the Life Plan, Vitality and the DiscoveryCard. The
results have exceeded expectation with 17% of sales of the Life Plan
utilising the Card Integrator. From a financial perspective, Vitality
performed particularly well - despite expensing entire start-up costs of
WellPoint, a corporate product launched during the period, which provides the
tools and incentives to create a healthy workplace.The DiscoveryCard
performed soundly, despite operational difficulties during the initial
implementation of the National Credit Act. These difficulties have since been
addressed.A number of fundamental enhancements were developed during the
period and will be launched into the market during September 2007. Destiny
HealthDestiny Health`s performance over the period was disappointing.
Discovery has made it clear in previous announcements that the last 24 months
have been particularly difficult for Destiny. A new management team was put
in place to address these difficulties and move the company onto a path of
growth and profitability. As part of the process, Discovery established a
number of strategic criteria for Destiny`s progress to ensure the appropriate
focus and discipline. Considerable progress was made in relation to many of
the key operational, product and market strategies; however, from a financial
perspective, the performance fell short of the criteria.Operationally, key
initiatives included: restructuring the partnerships with Tufts and Guardian;
announcement of a partnership with one of the world`s largest insurers Aegon;
selling Vitality as a stand-alone, non-risk product to large companies; and
expansion into new markets with more favourable pricing and a more favourable
competitive landscape.From a financial perspective, the Board set two
criteria:Operating losses cannot exceed 5% of the Group`s overall operating
profit - which was disclosed publiclyEach six-month period must be better
than the last.At the interim stage, Destiny`s financial performance was in
line with budget and comfortably in line with these measures and this
favourable performance continued from January through to April of this year.
Unfortunately, the financial performance in May and June was disappointing,
giving rise to an operating loss of
R102 million over the period (5.9% of Discovery`s operating profit). In
effect, therefore, two of the conditions set were breached during the period.
Over the past three months, intense work has been done to evaluate the
strategy going forward, taking into account the unique assets of the
Discovery Group and how they could be best positioned in the US. Discovery is
currently assessing a number of strategic options in this regard and will
announce the appropriate strategy on 15th October 2007. ProspectsDiscovery`s
businesses are well positioned for growth going forward without requiring
additional capital.
LL Dippenaar A Gore
Chairman Chief Executive Officer
3 September 2007
Directors
LL Dippenaar (Chairman), A Gore (Chief Executive Officer), JM Robertson*, Dr
BA Brink, JP Burger, Dr NJ Dlamini, SB Epstein (USA), PK Harris**, MI
Hilkowitz (Israel), NS Koopowitz*, Dr TV Maphai, HP Mayers*, A Pollard***, S
Sebotsa, B Swartzberg*, SV Zilwa, SD Whyte****
*Executive **Appointed 15 February 2007 ***Appointed 30 August 2007 ****
Resigned 30 August 2007
Transfer secretaries
Computershare Investor Services 2004 (Pty) Limited
(Registration number 2004/003647/07)
Ground Floor, 70 Marshall Street, Johannesburg, 2001
PO Box 61051, Marshalltown, 2107
Sponsors
Rand Merchant Bank (A division of FirstRand Bank Limited)
Secretary and registered office
MJ Botha Discovery Holdings Limited
155 West Street, Sandton, 2146 (Incorporated in the Republlic of
South Africa)
PO Box 786722, Sandton, 2146 (Registration number:
1999/007789/06)
Tel: (011) 529 2888 JSE share code: DSY
Fax: (011) 529 2958 ISIN: ZAE000022331
www.discovery.co.za
Income statement
for the year ended 30 June 2007
Group Group %
R million 2007 2006 Change
Insurance premium revenue 3 710 2 824
Reinsurance premiums (593) (456)
Net insurance premiums 3 117 2 368
Fee income from administration business 2 142 1 961
Investment income 175 161
Net realised gains on financial
instruments held
as available-for-sale 195 157
Net fair value gains on financial
instruments at fair value
through profit or loss 151 121
Vitality income 721 654
Net income 6 501 5 422
Insurance benefits and claims (1 919) (1 348)
Insurance claims recovered from 475 374
reinsurers
Net insurance benefits and claims (1 444) (974)
Acquisition costs (1 015) (908)
Marketing and administration expenses (3 069) (2 624)
Recovery of expenses from reinsurer 91 -
Transfer from assets/liabilities under 587 468
insurance contracts
- change in assets arising from 651 582
insurance contracts
- change in liabilities arising from (60) (113)
insurance contracts
- change in liabilities arising from (4) (1)
reinsurance contracts
Fair value adjustment to liabilities (141) (121)
under investment contracts
Profit before BEE expenses 1 510 1 263 20
BEE expenses (34) (161)
Profit from operations 1 476 1 102
Finance costs (21) (21)
Foreign exchange profit/(loss) - 3 (7)
unrealised
Share of profit from associate - 2
Profit before taxation 1 458 1 076 36
Taxation (385) (410)
Profit for the year 1 073 666 61
Attributable to:
Equity holders 1 073 669
Minority interests - (3)
1 073 666
Earnings per share for profit
attributable to the equity
holders during the year (cents):
- basic 200,0 126,5 58
- diluted 196,4 121,0 62
Balance sheet
at 30 June 2007
Group Group
R million 2007 2006
ASSETS
Property and equipment 228 186
Intangible assets including deferred acquisition costs 113 66
Assets arising from insurance contracts 3 114 2 463
Investment in associates 1 7
Financial assets 4 056 2 675
- Equity securities 2 155 1 600
- Debt securities 313 233
- Money market 577 206
- Equity linked notes 123 77
- Loans and receivables including insurance receivables 888 559
Deferred income tax 80 41
Current income tax asset 4 -
Reinsurance contracts 51 32
Cash and cash equivalents 996 1 322
Total assets 8 643 6 792
EQUITY
Capital and reserves
Share capital and share premium 1 393 1 348
Other reserves 912 640
Retained earnings 3 057 2 224
Total equity 5 362 4 212
LIABILITIES
Liabilities arising from insurance contracts 742 464
Liabilities arising from reinsurance contracts 20 24
Financial liabilities
- Investment contracts at fair value through profit or 735 604
loss
- Borrowings at amortised cost 73 161
Deferred income tax 806 518
Deferred revenue 122 203
Provisions 48 36
Trade and other payables 735 522
Current income tax liabilities - 48
Total liabilities 3 281 2 580
Total equity and liabilities 8 643 6 792
Cash flow statement
for the year ended 30 June 2007
Group Group
R million 2007 2006
Cash flow from operating activities 575 580
Cash generated by operations 799 439
Working capital changes (42) 217
757 656
Dividends received 43 33
Interest received 143 122
Finance costs (23) (22)
Taxation paid (345) (209)
Cash flow from investing activities (625) (138)
Net purchases of investments (456) (46)
Purchase of equipment (108) (59)
Disposal of equipment - 1
Purchase of intangible assets (61) (34)
Cash flow from financing activities (283) (39)
Proceeds from shares issued 48 23
Share issue costs written off against share capital - (4)
Dividends paid to equity holders (239) -
Dividends paid to Destiny Health preference shareholders - (1)
Minority share buy-back (5) (6)
(Repayment)/increase of borrowings (87) 16
Redemption of Destiny preference shareholders - (67)
Net (decrease)/increase in cash and cash equivalents (333) 403
Cash and cash equivalents at beginning of year 1 322 916
Effects of exchange rate changes on cash and cash 7 3
equivalents
Cash and cash equivalents at end of year 996 1 322
Statement of changes in equity
for the year ended 30 June 2007
Attributable to equity holders of the Company
Share Share-
capital based
and pay- Invest- Trans-
share ment ment lation
R million premium reserve reserve reserve
30 June 2006
Balance at 1 July 1 336 20 209 98
2005
Issue of capital 16 - - -
Share issue expenses (4) - - -
Share-based payments - 185 - -
Unrealised gains on - - 288 -
investments
Capital gains tax on
unrealised
gains on investments - - (39) -
Realised gains on
investments
transferred to - - (157) -
income statement
Capital gains tax on
realised
gains on investments - - 18 -
Currency translation - - - 14
differences
Transfer to hedging - - - -
reserve
Net profit for the - - - -
period
Dividends paid to
Destiny
Health preference - - - -
shareholders
Realised loss on
minority
share buy-back - - - -
Redemption of
Destiny Health
preference shares - - - -
Balance at 30 June 1 348 205 319 112
2006
30 June 2007
Balance at 1 July 1 348 205 319 112
2006
Issue of capital 45 - - -
Share-based payments - 52 - -
Unrealised gains on - - 458 -
investments
Capital gains tax on
unrealised
gains on investments - - (48) -
Realised gains on
investments
transferred to - - (195) -
income statement
Capital gains tax on
realised
gains on investments - - 8 -
Currency translation - - - 3
differences
Transfer to hedging - - - -
reserve
Net profit for the - - - -
period
Dividends paid to - - - -
equity holders
Realised loss on
minority
share buy-back - - - -
Balance at 30 June 1 393 257 542 115
2007
Attributable to equity
holders of the Company
Hedging Retained Minority
R million reserve earnings interest Total
30 June 2006
Balance at 1 July 3 1 557 67 3 290
2005
Issue of capital - - 3 19
Share issue expenses - - - (4)
Share-based payments - - - 185
Unrealised gains on - - - 288
investments
Capital gains tax on
unrealised
gains on investments - - - (39)
Realised gains on
investments
transferred to - - - (157)
income statement
Capital gains tax on
realised
gains on investments - - - 18
Currency translation - - - 14
differences
Transfer to hedging 1 - - 1
reserve
Net profit for the - 669 (3) 666
period
Dividends paid to
Destiny
Health preference - (1) - (1)
shareholders
Realised loss on
minority
share buy-back - (1) - (1)
Redemption of
Destiny Health
preference shares - - (67) (67)
Balance at 30 June 4 2 224 - 4 212
2006
30 June 2007
Balance at 1 July 4 2 224 - 4 212
2006
Issue of capital - - - 45
Share-based payments - - - 52
Unrealised gains on - - - 458
investments
Capital gains tax on
unrealised
gains on investments - - - (48)
Realised gains on
investments
transferred to - - - (195)
income statement
Capital gains tax on
realised
gains on investments - - - 8
Currency translation - - - 3
differences
Transfer to hedging (6) - - (6)
reserve
Net profit for the - 1 073 - 1 073
period
Dividends paid to - (239) - (239)
equity holders
Realised loss on
minority
share buy-back - (1) - (1)
Balance at 30 June (2) 3 057 - 5 362
2007
Segmental information
for the year ended 30 June 2007
Health
United
South States of United
R million Africa America Kingdom
30 June 2007
New business annualised premium income* 2 577 768 743
Gross inflows under management* 18 828 1 449 556
Income statement
Insurance premium revenue 158 921 278
Reinsurance premiums (3) (65) (25)
Fee income from administration business 2 138 - -
Investment income and gains 55 13 4
Vitality income - - -
Net income 2 348 869 257
Insurance benefits and claims (128) (707) (207)
Insurance claims recovered from 2 64 16
reinsurers
Acquisitions costs - (44) (32)
Marketing and administration expenses (1 432) (256) (314)
Recovery of expenses from reinsurer - - 91
Transfer from assets/liabilities under
insurance contracts 1 (15) (25)
Fair value adjustment to liabilities
under
investment contracts - - -
Expenses (1 557) (958) (471)
Profit from operations 791 (89) (214)
BEE expenses
Finance costs
Foreign exchange gain - unrealised
Profit before taxation
Taxation
Profit for the year
30 June 2006
New business annualised premium income* 2 505 796 282
Gross inflows under management* 16 542 1 322 141
Income statement
Insurance premium revenue 74 911 71
Reinsurance premiums (2) (81) -
Fee income from administration business 1 961 - -
Investment income and gains 34 9 4
Vitality income - - -
Net income 2 067 839 75
Insurance benefits and claims (57) (656) (43)
Insurance claims recovered from 2 76 -
reinsurers
Acquisitions costs - (82) (8)
Marketing and administration
expenses (1 319) (242) (153)
Transfer from assets/liabilities under
insurance contracts (4) (77) (13)
Fair value adjustment to liabilities
under
investment contracts - - -
Expenses (1 378) (981) (217)
Profit from operations 689 (142) (142)
BEE expenses
Finance costs
Foreign exchange loss - unrealised
Share of profit from associate
Profit before taxation
Taxation
Profit for the year
Life
South United
R million Africa Kingdom Vitality Total
30 June 2007
New business annualised premium 971 - 100 5 159
income*
Gross inflows under management* 2 357 - 721 23 911
Income statement
Insurance premium revenue 2 353 - - 3 710
Reinsurance premiums (500) - - (593)
Fee income from administration 4 - - 2 142
business
Investment income and gains 434 - 15 521
Vitality income - - 721 721
Net income 2 291 - 736 6 501
Insurance benefits and claims (877) - - (1 919)
Insurance claims recovered from 393 - - 475
reinsurers
Acquisitions costs (888) - (51) (1 015)
Marketing and administration (404) (36) (627) (3 069)
expenses
Recovery of expenses from - - - 91
reinsurer
Transfer from assets/liabilities
under
insurance contracts 626 - - 587
Fair value adjustment to
liabilities under
investment contracts (141) - - (141)
Expenses (1 291) (36) (678) (4 991)
Profit from operations 1 000 (36) 58 1 510
BEE expenses (34)
Finance costs (21)
Foreign exchange gain - unrealised 3
Profit before taxation 1 458
Taxation (385)
Profit for the year 1 073
30 June 2006
New business annualised premium 789 - 107 4 479
income*
Gross inflows under management* 1 768 - 654 20 427
Income statement
Insurance premium revenue 1 768 - - 2 824
Reinsurance premiums (373) - - (456)
Fee income from administration - - - 1 961
business
Investment income and gains 382 - 10 439
Vitality income - - 654 654
Net income 1 777 - 664 5 422
Insurance benefits and claims (592) - - (1 348)
Insurance claims recovered from 296 - - 374
reinsurers
Acquisitions costs (752) - (66) (908)
Marketing and administration
expenses (363) - (547) (2 624)
Transfer from assets/liabilities
under
insurance contracts 562 - - 468
Fair value adjustment to
liabilities under
investment contracts (121) - - (121)
Expenses (970) - (613) (4 159)
Profit from operations 807 - 51 1 263
BEE expenses (161)
Finance costs (21)
Foreign exchange loss - unrealised (7)
Share of profit from associate 2
Profit before taxation 1 076
Taxation (410)
Profit for the year 666
* New business annualised premium income and gross inflows under management
include flows of the schemes Discovery administers and 100% of the business
conducted together with its joint venture partners.
Embedded value statement
for the year ended 30 June 2007
The embedded value of Discovery at 30 June 2007 is calculated as the sum of
the following components:
the excess assets over liabilities at the valuation date (i.e.
shareholders` funds); and
the value of in-force business at the valuation date (less an allowance for
the cost of capital and secondary tax on companies (STC)).
The value of in-force business is calculated as the value of projected future
after-tax profits of the business in force at the valuation date, discounted
at the risk discount rate.
Prior to 31 December 2005, Life based the embedded value on the Financial
Soundness Valuation Method (FSV). A change in actuarial guidance (PGN107)
effective for financial year-ends on or after 31 December 2005 required long-
term insurers to base the embedded value on the Statutory Valuation Method
(SVM). The key difference between the two bases for Life is that the value
capitalised in the assets under insurance contracts on the FSV basis may not
be reflected as an insurance asset under the SVM. The net asset value shown
on the published balance sheet has been adjusted to reflect the elimination
of the assets under insurance contracts as per the Life statutory accounts.
The value of the assets under insurance contracts on the FSV basis is
released in the value of in-force of the Statutory Valuation Method over
time. The capital maintained for Life throughout the projection term is based
on the statutory capital as defined by the SVM.
The value of new business is determined at the point of sale equal to the
projected future after-tax profits of the new business written by Discovery,
discounted at the risk discount rate, less an allowance for the cost of
capital and STC.
For Destiny Health, no published value has been placed on the current in-
force business. Due to fundamental changes to the alliances with Tufts and
Guardian over the past 6 months as well as the changes to the business as a
result of the marketing alliance with AEGON, the current book of in-force
business is relatively small. Experience with regard to the key embedded
value assumptions has also been volatile over the past 12 months. This has
made it difficult to set reliable assumptions with regard to future
experience. Embedded value calculations on a range of realistic assumption
sets indicate that the value of in-force is essentially zero.
For PruHealth, no value has been placed on the current in-force business due
to the relatively small book of business which results in the underlying
experience being statistically volatile.
The auditors, PricewaterhouseCoopers Inc., have reviewed the embedded value
statement for the year ended 30 June 2007. A copy of the auditors`
unqualified report is available for inspection at the company`s registered
office.
Table 1: Group embedded value
at 30 June
30 June 30 June 30 June
2007 2007 2006
10 year term 20 year term
for Health for Health %
R million and Vitality and change(2)
Vitality(1)
Shareholders` 5 362 5 362 4 212 27
funds
Elimination of (2 813) (2 813) (2 088)
assets under
insurance
contracts
Shareholders`
funds excluding
assets under
insurance 2 549 2 549 2 124
contracts
Value of in-force 10 556 11 776 8 774
business before
cost of capital
Cost of capital (32) (32) (60)
Cost of STC(3) (247) (275) (251)
Discovery 12 826 14 018 10 587 21
Holdings embedded
value
Number of shares 538,7 538,7 533,4
(millions)
Embedded value R23,81 R26,02 R19,85 20
per share
Diluted number of 559,7 559,7 553,2
shares (millions)
Diluted embedded R23,25 R25,38 R19,47 19
value per
share(4)
(1) The term of the Health and Vitality projection is currently set at 10
years. There is significant value in the business after 10 years. Since it is
managements` intention to move to a 20 year projection term for Health and
Vitality in future, the result of the embedded value based on the extended
term is also shown. For the 20 year term projection, the lapse rate
assumption in the later years has been increased. The analysis of the change
in embedded value below is based on a 10 year projection term. Note that the
projection term of the Group Life product remains at 10 years.
(2) This shows the change in values between June 2006 and June 2007 based on
a 10 year term for Health and Vitality.
(3) In line with Discovery`s current dividend policy, the cost of STC is
calculated assuming a 4,5 times dividend cover on the after-tax profits as
they emerge over the projection term. The STC rate is assumed to decrease
from 12,5% in 2007 to 10% for the remainder of the projection term. The total
STC charge has been allocated between the different business entities based
on their contribution to the total value of in-force.
(4) The diluted embedded value per share is calculated by increasing the
embedded value by the value of the loan to the Discovery Holdings share
trust, and by increasing the number of shares by the number of shares issued
to the share incentive trust which have not been delivered to participants.
An allowance has been made for Discovery`s BEE transaction where the impact
is dilutive i.e. where the current embedded value per share exceeds the
current transaction value.
Table 2: Value of in-force business
Value before Value after
cost of Cost of Cost of cost of
capital capital
R million and STC capital STC and STC
at 30 June 2007 -
10 year term for
Health
and Vitality
Health and 4 558 - (107) 4 451
Vitality
Life(1) 5 998 (32) (140) 5 826
Total 10 556 (32) (247) 10 277
at 30 June 2007 -
20 year term for
Health
and Vitality
Health and 5 778 - (135) 5 643
Vitality
Life(1) 5 998 (32) (140) 5 826
Total 11 776 (32) (275) 11 469
at 30 June 2006
Health and 4 258 - (122) 4 136
Vitality
Life(1) 4 496 (45) (129) 4 322
Destiny Health 20 (15) (0) 5
Total 8 774 (60) (251) 8 463
(1) On the SVM basis, the Life cost of capital is based on a capital adequacy
requirement at June 2007 of R145 million. (June 2006: R94 million on the SVM
basis).
Table 3: Group embedded value earnings
for the year ended 30 June
R million 2007 2006
Embedded value at end of period 12 826 10 587
Less: Embedded value at beginning of period (10 587) (9 173)
Increase in embedded value 2 239 1 414
Net issue of capital (45) (12)
Dividends paid 239 1
Realised loss on minority share buy-back 1 1
Transfer to hedging reserve 6 (1)
Embedded value earnings 2 440 1 403
Return on opening embedded value 23,0% 15,3%
Table 4: Components of Group embedded value earnings
for the year ended 30 June
%
R million 2007 2006 change
Total profit from new business (at point of sale) 685 572 20
Profit from existing business
Expected return 1 030 756
Change in methodology and assumptions(1) (13) (540)
Experience variances(2) 553 262
Reversal of Destiny Health opening value of in- (5) -
force
Destiny Health and other new initiative costs(3) (338) (128)
Acquisition costs(4) (27) -
Adjustment for minority interest in Destiny - 10
Health
Adjustment for Guardian profit share in Destiny - 1
Health
Foreign exchange rate movements 3 (4)
Cost of STC 16 -
Return on shareholders` funds(5) 536 474
Embedded value earnings 2 440 1 403 74
(1) The change in methodology and assumptions item will vary over time to
reflect adjustments to the model and assumptions as a result of changes to
the operating and economic environment. The current period`s changes are
described in detail in Table 5 below (for previous periods refer to previous
embedded value statements). The methodology and assumption changes for June
2007 are based on the SVM method. The methodology and assumption changes for
June 2006 are based on the FSV methodology.
(2) The experience variances for June 2007 are shown on the SVM methodology.
The experience variances for June 2006 are shown on the FSV methodology.
(3) For 2006, the new initiative costs reflect the expenses relating to the
establishment of PruHealth. For 2007, this includes the expenses relating to
the establishment and support of PruHealth, PruProtect, the Life investment
product and Destiny Health. These costs have not been projected on a
recurring basis in the embedded value due to the fact that income from
business sold under these initiatives has not been projected. The split
between PruHealth, PruProtect and Destiny Health is shown in the segmental
income statement.
(4) Acquisition costs relate to commission paid on Life business that has
been written over the period but that will only be activated and on risk
after the valuation date. These policies are not included in the embedded
value or the value of new business and thus the commission costs are
excluded.
(5) Return on shareholders` funds is shown net of tax and management charges
under the SVM method.
Table 5: Methodology and assumption changes
for the year ended 30 June 2007
Health and Vitality Life
Net Value of Net Value of
R million worth in-force worth in-force Total
Modelling changes(1) - - (138) 158 20
Cost of capital - - - (97) (97)
modelling changes(2)
Economic assumptions - (2) (2) 30 26
Lapse assumption(3) - - 4 (63) (59)
VAT assumption(4) - (187) - - (187)
Benefit - - 1 (12) (11)
enhancements(5)
Expenses(6) - 218 (2) (5) 211
Administration - (39) - - (39)
fees(7)
Vitality benefits - (22) - - (22)
Mortality and - - 3 142 145
morbidity(8)
Total - (32) (134) 153 (13)
(1) The Life modelling changes primarily relate to the modelling of future
commission payments and changes to the Global Linkage benefit model. In
addition, negative reserves are now zeroised on a per policy level whereas in
the past the negative reserve was zeroised on a portfolio level thus reducing
the net worth but increasing the value of in-force.
(2) The cost of capital modelling change primarily relates to a change in the
projection of future capital requirements and the costs associated with
future capital requirements. In addition, the cost of capital now assumes
that the capital adequacy requirement is backed by assets consisting of 100%
equities in all future periods. Previously, it was assumed to be backed by
assets consisting of 70% equities and 30% fixed interest securities.
(3) The Life lapse assumption has been increased following higher than
expected lapse experience.
(4) This reflects an increase in the average VAT rate modelled to 14%.
(5) The Life benefit enhancements relate primarily to enhancements on the
Health Plan Protector and Integrator products.
(6) The renewal expense assumption change is based on the results of the most
recent expense and budget information.
(7) This reflects the present value impact of a R15 million reduction in the
Health administration fees for the 2008 calendar year.
(8) The Life mortality and morbidity assumption was weakened to partly
reflect the significant and sustained historic claims experience variances.
Table 6: Experience variances
for the year ended 30 June 2007
Health and Vitality Life
Net Value of Net Value of
R million worth in-force worth in-force Total
Renewal expenses 44 - 11 - 55
Non-recurring (8) - (9) - (17)
expenses(1)
Economic assumptions 0 0 5 (17) (12)
Extended modelling - 235 - 8 243
term(2)
Lapses(3) 11 109 (15) (8) 97
Cancellations(4) - - 6 (26) (20)
Policy alterations - 10 (17) 124 117
Premium increases - - 3 9 12
Mortality and 17 - 52 33 102
morbidity(5)
Deferred profits - - 39 (39) -
released
Tax (12) - (10) 3 (19)
Timing of 19 - (25) 21 15
cashflows(6)
Administration 11 (23) - - (12)
fees(7)
Other 14 3 (25) (0) (8)
Total 96 334 15 108 553
(1) The Health and Vitality non-recurring expenses relate to expenses
incurred in the development of the WellPoint product. For Life, this relates
to non-recurring expenses incurred in the establishment of the Smartcall
Joint Venture and a new distribution channel.
(2) The projection term for Health, Vitality and Group Life at 30 June 2007
has not been changed from the 10 year term used at 30 June 2006. Thus, an
experience variance arises because the total term of the in-force business is
effectively increased by one year.
(3) Included in the Health and Vitality lapse experience variance is an
amount of R373 million in respect of members joining existing employer groups
during the period, offset by an amount of R282 million in respect of members
leaving existing employer groups. A positive variance of R30 million is due
to lower than expected lapses.
(4) Backdated cancellations are in respect of policies cancelled to the
inception date with a corresponding refund of premiums.
(5) For Health, this relates to risk profits earned on the Select benefit
options and the Keycare capitation arrangement.
(6) In practice certain cashflows occur earlier during the period than
expected and thus gives rise to value differences.
(7) In July 2007, Discovery Health agreed to reduce administration fees
charged to Discovery Health Medical Scheme by approximately R3 million per
month before tax for the 2007 calendar year (backdated to 1 January 2007).
This reduction has been allowed for in the embedded value projection with
effect from 1 January 2007 but has not been included in the income statement.
Table 7: Embedded value of new business
for the year ended 30 June
2007 2007
10 year term 20 year term
for Health for Health %
R million and Vitality and Vitality 2006 change(1)
Health and
Vitality
Gross profit 71 129 115
from new
business at
point of sale
Cost of - - -
capital
Cost of STC (2) (3) (3)
Net profit from 69 126 112 (38)
new business at
point of
sale(2)
New business 1 011 1 011 1 121 (10)
annualised
premium
income(3)
Life
Gross profit 639 639 532
from new
business at
point of sale
Cost of (8) (8) (7)
capital
Cost of STC (15) (15) (15)
Net profit from 616 616 510 21
new business at
point of sale
New business 695 695 592 17
annualised
premium
income(4)
Annualised 10,1% 10,1% 10,8%
profit
margin(5)
Destiny Health
Gross profit - - (50)
from new
business at
point of sale
Cost of - - (0)
capital
Cost of STC - - 0
Net profit from - - (50)
new business at
point of sale
New business - - 457
annualised
premium income
New business
annualised
premium income
(US$ million) - - 71
(1) This shows the change in values between June 2006 and June 2007 based on
a 10 year term for Health and Vitality.
(2) The value of new business at 30 June 2007 using a 10 year projection
term, net of acquisition costs incurred, was R232 million (30 June 2006: R292
million).
(3) Health new business annualised premium income is the gross contribution
to the medical schemes. For embedded value purposes, Health new business is
defined as individuals and members of new employer groups, and includes
additions to first year business.
The new business annualised premium income shown above has been adjusted to
exclude premiums in respect of members who join an existing employer after
the first year, as well as premiums in respect of new business written during
the period but only activated after 30 June 2007.
The total Health and Vitality new business annualised premium income written
over the period was R2 677 million (June 2006: R2 612 million).
(4) Life new business is defined as policies which incepted during the
reporting period and which are on risk at the valuation date.
The new business annualised premium income of R695 million shown above
excludes automatic premium increases and servicing increases in respect of
existing business. The total Life new business annualised premium income
written over the period, including both automatic premium increases of R155
million and servicing increases of R121 million was R971 million. Single
premium business is included at 10% of the variance of the single premium.
Discovery Retirement Optimisers added to existing Life Plans have been
included in the value of new business (other policy alterations are shown in
Table 6 as experience variances and not included as new business).
(5) The annualised profit margin is the value of new business expressed as a
percentage of the present value of future premiums.
Table 8: Embedded value assumptions
at 30 June
2007 2006
Risk discount rate (%)
- Health and Vitality 11,75 12,00
- Life 11,75 12,00
- Destiny Health - 10,00
Medical inflation (%)
South Africa 7,75 8,00
United States - Current levels
reducing
to 13,00% over
the projection
period
Expense inflation (%)
South Africa 4,75 5,00
United States - 3,00
Pre-tax investment return
(%)
South Africa - Cash 7,25 7,50
- Bonds 8,75 9,00
- Equity 10,75 11,00
United States - Bonds - 3,00
Dividend cover ratio 4,5 times 4,5 times
Income tax rate (%)
- South Africa 29,00 29,00
- United States Federal - 34,00
Tax Rate(1)
(1) Various additional State taxes also apply.
Life mortality, morbidity and lapse assumptions were derived from internal
experience, where available, augmented by reinsurance and industry
information.
The Health lapse assumptions were based on the results of recent experience
investigations. The lapse rate for the projection term after 10 years was
increased above current experience.
Renewal expense assumptions were based on the results of the latest expense
and budget information. A notional allocation of corporate overhead expenses
has been made to each of the subsidiary companies based on managements` view
of each subsidiary`s contribution to overheads. This includes allocations to
the overseas operations (Destiny Health, Pruhealth and PruProtect) which have
not been projected on a recurring basis in the embedded value due to the fact
that the income from business sold under these initiatives has not been
projected in the embedded value. The corporate overhead expense allocation to
Destiny Health is not included under Destiny Health in the segmental income
statement.
The investment return assumption was based on a single interest rate derived
from the risk-free zero coupon yield curve. Other economic assumptions were
set relative to this yield. The risk discount rate has been set relative to
the risk-free rate, increased by a risk premium. The current and projected
tax position of the policyholder funds within the Life company has been taken
into account in determining the net investment return assumption.
It was assumed that the capital adequacy requirements in future years will be
backed by surplus assets consisting of 100% equities for the purposes of
calculating the cost of capital at risk. Allowance has been made for tax and
investment expenses in the calculation of the cost of capital.
Sensitivity to the embedded value assumptions
In order to illustrate the effect of using different assumptions, the
sensitivity of the embedded value at 30 June 2007 to changes in the key
assumptions is shown below. For each sensitivity illustrated, all other
assumptions have been left unchanged. No allowance has been made for
management action such as risk premium increases where future experience is
worse than the base assumptions.
Table 9: Embedded value sensitivities
Shareholders`funds Health and Vitality
excluding assets
under insurance Value Cost of Cost of
R million contracts in-force capital STC
Base 2 549 4 558 - (107)
Impact of:
Risk discount rate + 2 549 4 395 - (102)
1%
Risk discount rate - 2 549 4 731 - (112)
1%
Lapses + 10% 2 549 4 475 - (105)
Investment return - 2 549 4 558 - (93)
1%(1)
Renewal expenses + 2 549 4 051 - (95)
10%
Mortality and 2 549 4 558 - (107)
morbidity + 10%
Health and Vitality:
Projection term + 1 2 549 4 788 - (112)
year
Life
Value Cost of Cost of Embedded %
R million in-force capital STC value change
Base 5 998 (32) (140) 12 826
Impact of:
Risk discount rate 5 532 (42) (128) 12 204 (5)
+ 1%
Risk discount rate 6 556 (20) (155) 13 549 6
- 1%
Lapses + 10% 5 667 (29) (133) 12 424 (3)
Investment return - 5 673 (42) (116) 12 529 (2)
1%(1)
Renewal expenses + 5 935 (32) (139) 12 269 (4)
10%
Mortality and 5 450 (34) (127) 12 289 (4)
morbidity + 10%
Health and
Vitality:
Projection term + 1 5 998 (32) (140) 13,051 2
year
(1) For Life, both investment return and inflation assumptions were reduced
by 1%.
The following table shows the effect of using different assumptions on the
value of new business.
Table 10: Value of new business sensitivities
Health and Vitality
Value of Cost of Cost of
R million in-force capital STC
Base 71 - (2)
Impact of:
Risk discount rate + 1% 62 - (1)
Risk discount rate - 1% 80 - (2)
Lapses + 10% 66 - (2)
Investment return - 1%(1) 71 - (1)
Renewal expenses + 10% 32 - (1)
Mortality and morbidity + 10% 71 - (2)
Health and Vitality: Projection
term + 1 year 82 - (2)
Acquisition expenses + 10% 53 - (1)
Life
Value
Value of Cost of Cost of of new %
R million in-force capital STC business change
Base 639 (8) (15) 685
Impact of:
Risk discount rate 517 (11) (14) 553 (19)
+ 1%
Risk discount rate 787 (5) (17) 843 23
- 1%
Lapses + 10% 556 (7) (14) 599 (13)
Investment return - 556 (11) (12) 603 (12)
1%(1)
Renewal expenses + 623 (8) (15) 631 (8)
10%
Mortality and 516 (9) (14) 562 (18)
morbidity + 10%
Health and
Vitality:
Projection
term + 1 year 639 (8) (15) 696 2
Acquisition 605 (8) (14) 635 (7)
expenses + 10%
(1) For Life, both investment return and inflation assumptions were reduced
by 1%.
Review of Group results
Gross inflows under management, increased 17% for the year ended 30 June
2007. Gross inflows under management includes flows of the schemes Discovery
administers and 100% of the business conducted together with its joint
venture partners.
Gross inflows under management
June June %
R million 2007 2006 change
Discovery Health 18 828 16 542 14
Discovery Life 2 357 1 768 33
Discovery Vitality 721 654 10
Destiny Health 1 449 1 322 10
PruHealth 556 141 294
Gross inflows under management 23 911 20 427 17
Less: collected on behalf of third (17 338) (14 988) 16
parties
Discovery Health (16 532) (14 507)
Destiny Health (528) (411)
PruHealth (278) (70)
Gross income of Group 6 573 5 439 21
Earnings
The following table shows the main components of the increase in Group profit
from operations excluding investment income for the year:
Earnings source
June June %
R million 2007 2006 change
Discovery Health 736 655 12
Discovery Life 707 546 29
Discovery Vitality 43 41 5
PruProtect (36) - -
Destiny Health (102) (151) 32
PruHealth (218) (146) (49)
Group operating profit before investment 1 130 945 20
income
Investment income 175 161 9
Realised gains on shareholders portfolios 195 157 24
Investment returns on assets backing 151 121 25
policyholder liabilities
Fair value adjustment to liabilities under (141) (121) 17
investment contracts
Profit from operations before BEE expenses 1 510 1 263 20
Headline earnings
Headline earnings in compliance with International Financial Reporting
Standards (IFRS) increased by 33% excluding the impact of the BEE
transaction.
Unrealised gains of R458 million on available-for-sale investments for the
year have been taken directly to equity and are not included in earnings or
headline earnings.
The reconciliation between earnings and headline earnings is shown below:
June June %
R million 2007 2006 change
Net profit attributable to equity 1 073 669 60
shareholders
Adjusted for:
- realised profit on available-for-sale (187) (139)
investments net of CGT
- impairment of property and equipment - 1
Headline earnings 886 531 67
BEE expenses 34 161
Headline earnings before BEE 920 692 33
transaction
Headline earnings per share before BEE
transaction (cents):
- undiluted 171,5 130,8 31
- diluted 168,4 126,4 33
Headline earnings per share (cents):
- undiluted 165,2 100,4 65
- diluted 162,2 97,0 67
Weighted number of shares in issue 536 560 528 946
(000`s)
Diluted weighted number of shares 546 579 574 871
(000`s)
Taxation
All South African entities are in a tax paying position. Destiny operations
have significant tax losses but no deferred tax asset has been accounted for
on the foreign losses incurred in the US.
During the year, PruHealth entered into a transaction with Prudential
Assurance Company Limited ("Prudential") to effectively utilise the tax
losses that Discovery has been unable to utilise through consortium relief,
such that PruHealth`s deferred tax asset is replaced with a cash injection
from Prudential. Previously, Discovery was only able to account for an asset
on 50% of the PruHealth losses for which consortium relief was available to
Prudential in the UK. The utilisation of the tax losses has enabled Discovery
to account for a receivable for the balance of the PruHealth losses. The
impact of this is to reduce the taxation charge in the current year by R120
million, of which R52 million relates to prior years` tax assets not
recognised.
Investments
Equity investments have increased due to additional investments and the
continued strong performance of the equity markets. This has resulted in an
increase in investment income.
Balance sheet
The increase in the assets arising from insurance contracts of R651 million
is as a result of profitable new business written by Discovery Life.
The deferred tax liability is primarily attributable to the application of
the Financial Services Board directive 145. This directive allows for the
zeroing on a statutory basis of the assets arising from insurance contracts.
The statutory basis is used when calculating tax payable for Discovery Life,
resulting in a timing difference between the tax base and the accounting
base.
Share-based payments
The issue of 38,7 million shares by Discovery in terms of its BEE transaction
in 2005 has been accounted for in terms of IFRS2. These shares are not
accounted for as issued in the consolidated accounts of Discovery but rather
as a share option transaction. These shares have been considered in the
calculation of diluted HEPS and diluted EPS.
The BEE transaction has resulted in a charge to the income statement of R34
million in the year ended 30 June 2007 (2006: R161 million) in accordance
with the requirements of IFRS 2.
An additional R63 million (2006: R29 million) in respect of options granted
under employee share incentive schemes has been expensed in the income
statement for the year in accordance with the requirements of IFRS 2.
Accounting policies
The annual financial statements have been prepared in accordance with IFRS as
well as the South African Companies Act 61 of 1973, as amended, and are
consistent with the accounting policies applied in the previous financial
reporting period.
Directorate
Mr P K Harris was appointed as a non-executive director to the board of
Discovery with effect from 15 February 2007.
Mr SD Whyte resigned and Mr A Pollard was appointed as an executive director
to the board of Discovery with effect from 30 August 2007.
Dividend policy and capital
An interim dividend of 16 cents per share was paid on 2 April 2007.
The directors are of the view that the Discovery Group is adequately
capitalised at this time. On the statutory basis the capital adequacy
requirements of Discovery Life were R145 million (2006: R94 million) and were
covered 10,7 times (2006: 14,0 times).
Dividend Declaration:
The board has declared a final dividend of 21 cents per share. The salient
dates are as follows:
- Last date to trade "cum" dividend Friday, 12 October 2007
- Date trading commences "ex" dividend Monday, 15 October 2007
- Record date Friday, 19 October 2007
- Date of payment Monday, 22 October 2007
Share certificates may not be dematerialised or rematerialised between
Monday, 15 October 2007 and Friday, 19 October 2007, both days inclusive.
Audit
The auditors, PricewaterhouseCoopers Inc., have issued their opinion on the
Group financial statements for the year ended 30 June 2007. A copy of the
auditors` unqualified report is available for inspection at the company`s
registered office.
Date: 04/09/2007 11:00:01 Produced by the JSE SENS Department.
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