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Discovery Holdings Limited - Unaudited Interim Results For The Six Months Ended
31 December 2002
DISCOVERY HOLDINGS LIMITED
(Registration : 1999/007789/06)
ISIN : ZAE000022331
Share Code : DSY
Our purpose is clear: to make people healthier and protect and enhance their
lifestyles
Unaudited interim results for the six months ended 31 December 2002
Highlights
Operating profit from local operations +30%
Operating profit before taxation +16%
Earnings per share +5%
New business premium income +36%
Discovery Life embedded value R500m
Embedded value per share R9,56
Destiny Health to conclude agreement with major US insurance company
Introduction
The performance of Discovery over the first six months of the 2003 financial
year has been pleasing. Discovery`s health business continues to consolidate its
leadership position locally, while transferring its unique capabilities to the
US market. To leverage this, a significant agreement with a major US insurance
company is in the process of being concluded.
Discovery`s life business has exceeded expectations and is playing a leadership
role in creating structural change in the mainstream life assurance market.
Over the period under review, Discovery`s performance has resulted in strong
organic growth and the creation of platforms and opportunities for future
growth.
Discovery Health
Discovery Health`s performance exceeded expectation. The environment in which
the company operates is complex and fluid, but one with considerable consumer
demand. Given the company`s unique skill sets and capabilities, the environment
presented ongoing opportunities for it to continuously differentiate itself and
enhance its competitive position. The resolution with the Council for Medical
Schemes enabled it over the period to focus on its core capabilities and
infrastructure resulting in an exceptional performance of the Discovery Health
Medical Scheme ("DHMS"), enhanced service levels to members, considerable growth
in new business and the emergence of new market opportunities.
* Annualised new business increased by 27% to R1 163,3m from R917,7m. The lapse
rate of members reduced to an effective 3,3% per annum, the lowest to date. This
resulted in covered lives increasing from 1 049 916 to 1 255 797.
* The reserves within the Discovery Health Medical Scheme increased by R331m
over the six-month period, increasing the scheme`s statutory solvency level to
7,3% which meets the level agreed to with the Council for Medical Schemes.
Importantly, a more co-operative, productive relationship has been formed
between the Council for Medical Schemes, Discovery Health and the Discovery
Health Medical Scheme.
* The financial and operational performance of the Discovery Health Medical
Scheme enabled it to post amongst the lowest contribution increases for 2003,
clearly fulfilling Discovery`s commitment to providing access to the best
quality care on a sustainable basis.
* The KeyHealth product was launched providing an important foundation for entry
into the employed but uninsured market. Early indications are that growth will
exceed expectations.
* Substantial focus on technology and infrastructure yielded an increase in
service levels and operational efficiency, driving member satisfaction and
profitability.
* The regulatory environment, while in constant flux, has become more stable,
predictable and workable. The proposed Public Sector Medical Scheme for state
employees poses a unique opportunity and Discovery Health is well positioned to
tender for a role as one of its administrators.
Destiny Health
The period under review was an important and exciting one for Destiny Health,
Discovery`s US subsidiary. The emerging environment is now particularly
conducive to Discovery`s approach and partnership opportunities are emerging to
leverage this. The partnership strategy is one which Discovery will continue
pursuing. With reference to the cautionary announcement issued by Discovery on
17 December 2002 and renewed on 27 January 2003, shareholders are advised that
Destiny is in the process of concluding an agreement with a major US insurance
company. This respected Fortune 500 company has been recognised by Fortune
magazine in areas including financial soundness, product quality and employee
talent. The capability developed within Destiny combined with Discovery Health`s
unique competence in what the US healthcare system terms "consumer-driven
healthcare" (the combination of medical savings accounts and insurance
coverage), has created significant opportunities to capitalise on the move
toward consumerism in the US healthcare system. This relationship will create
the first mainstream consumer-driven offering in the US marketplace. It will
pivot around Discovery`s Comprehensive Consumer-Driven Health CareT model. This
agreement will give Destiny access to significant brand and financial
credibility, nationwide distribution and the ability to share the variable cost
of market expansion.
Independently of this, the company has the intention of reaching cash flow
breakeven on a monthly basis by the end of the 2003 calendar year. Towards this,
Destiny`s performance over the period was pleasing on the new business side,
with production accelerating considerably, reflecting the significant progress
made in product competitiveness and distribution effectiveness. The company
spent significantly on infrastructure leading to a financial result that fell
short of expectation. While much of the infrastructure built will be required to
support the company`s new partnership, significant steps have been taken to
address certain infrastructural costs and the company is confident that the next
six months will see the combined impact of increased business and leaner
infrastructure.
The period under review contained important milestones:
* The monthly production of new business increased to a level above 1 500
members per month. Total lives covered grew from 3 866 to 14 840. For January
2003 (post the reporting period), new business increased to 2 800 new lives,
reflecting a significant increase in demand.
* Despite rapid growth, service levels have remained at exceptional levels,
exceeding broker and client expectations - an important aspect in creating
demand and building credibility.
* A general agency agreement was signed with Euclid Managers, Illinois` most
prestigious General Agent, who will now distribute only Destiny`s product
through its 1 600 brokers to companies over 50 lives.
* The Destiny product range was enhanced making it more flexible, modular and
price competitive.
* Significant progress was made in moving functionality to Discovery in South
Africa, creating the potential to reduce operating costs. Currently 25% of
client calls are being dealt with by call centres within Discovery.
Discovery Life
Discovery Life`s performance was particularly pleasing. Two years ago, Discovery
set out to create a new generation life assurance company to meet the needs of
its clients in a different and more appropriate way, utilising its risk and
health management capabilities. The result of this is its "risk-only" approach
to life insurance - as opposed to the conventional combination of risk and
investment - has had a structural impact on the life assurance market. The
unique product architecture and benefits of Discovery Life`s LIFE PLAN, the
franchise distribution system and the overall positioning of Discovery has
provided a strong platform for competitive advantage and growth, translating
into a pleasing performance over the period:
* Annualised recurring new business premium over the six-month period grew by
95,8% to R214,6m from R109,6m, placing Discovery Life amongst the top life
assurance companies in terms of new risk business production.
* Pre-tax profit grew to R20,2m from a loss of R1,3m in the previous period. The
quality of business written is reflected in the growth of the embedded value to
R500m from R183,3m.
* During the period, Discovery Life launched the Integrator, enabling clients of
Discovery Life, Discovery Health and Vitality to enjoy the benefit of dynamic
health management resulting in significant reductions in their life assurance
premiums. This unique capability places both Discovery Life and Discovery Health
in an enhanced competitive position that is difficult to replicate.
* Discovery Consulting Services (DCS), Discovery Life`s franchise distribution
capability, reached full operational efficiency, with each franchise meeting
expense to revenue targets, thereby creating a powerful channel for future
growth.
* The major life assurance companies have begun migrating toward the Discovery
Life approach of risk-only product architecture, thereby endorsing the Discovery
approach. Discovery Life`s positioning makes it a leader in this mainstream
emerging market and places it in a strong competitive position for the future.
Discovery Vitality
Vitality continues its role of making people healthier and differentiating the
product offerings of Discovery Health and Discovery Life. The effect has been to
increase new business production and retention, while having a positive
influence on the underlying morbidity and mortality experience.
Profit before investment income for the period decreased from R23,1m to R11,7m,
reflecting the increase in benefit offerings, including the highly successful
Ster-Kinekor structure. The overall result has been that the total number of
people enjoying significant benefits is now greater than ever, leading to even
higher persistency levels in both Discovery Health and Discovery Life.
KeyClub was launched as an adjunct to the recently introduced KeyHealth product.
This includes movie benefits, magazine benefits, discounts on pre-paid airtime
and membership of Kaizer Chiefs and Orlando Pirates Supporters clubs.
New Vitality benefits were added for 1 January 2003, including Sony products,
cell phone airtime and Internet access.
By order of the board
L L Dippenaar A Gore
Chairman Chief Executive Officer
25 February 2003
Financial commentary
Effect of resolution on Discovery Health
On 25 May 2002 resolution was reached with the Council for Medical Schemes. The
resolution resulted in the following key features, with effect from 1 January
2002, which had an impact on the current financial statements:
* The administration fee earned by Discovery Health was reduced from 14% to
12,4% of DHMS`s gross contributions.
* Quota share reinsurance premiums earned by Discovery Life from DHMS, were
reduced from 67% to 33% of risk premiums received and a profit share arrangement
was concluded.
* A stop-loss reinsurance agreement was entered into between DHMS and Discovery
Life for a loss ratio in excess of 102,3% of risk premiums received by DHMS.
The impact of the above, on the results of the health operations of Discovery,
is a reduction in gross income for the six months ended 31 December 2002, as
compared to the six months ended 31 December 2001, with a corresponding decrease
in reinsurance, claims and policyholder benefits and transfers to health
insurance durational and AIDS reserves.
Implementation of new accounting standards
Discovery implemented the Accounting Standard AC133 - Financial Instruments:
Recognition and Measurement in preparation of the financial statements for the
six months ended 31 December 2002.
In order to comply with the requirements of AC133, Discovery separates linked
investment contracts written from other insurance contracts and discloses the
liabilities in respect of these contracts separately. Premium income, investment
income and outflows in respect of linked investment contracts are excluded from
the income statement.
Investments held by Discovery are also split between shareholder assets and
policyholder assets. The accounting treatment in respect of each category of
assets is as follows:
* Policyholder investments: These investments represent investments held in
respect of linked investment contracts and are classified as investments
available for sale. Fair value is determined by reference to market value.
Investment income, including unrealised gains and losses, is taken directly to
the liabilities on linked investment contracts.
* Shareholder investments: These investments are classified as investments
available for sale. Fair value is determined by reference to market value.
Unrealised gains and losses on revaluation of shareholder investments are
recognised directly in equity through the statement of changes in equity.
AC133 is prospectively applied. The implication of this is that the comparative
figures included in the financial statements were not adjusted to take into
account the effect of AC133.
New business annualised premium income ("API")
All lines of business showed strong new business growth. New business API of the
group grew 36% for the six months under review to R1 597,7m (2001: R1 172,2m),
made up as follows:
2002 2001 %
Health (Rm) 1 163,3 917,7 27
Vitality (Rm) 32,9 26,2 26
Life (Rm) 214,6 109,6 96
Destiny (USDm) 19,7 10,7 84
Gross inflows under management
Gross inflows under management include flows into DHMS to demonstrate the scale
of activity of the Discovery group and to provide direct comparison of activity
to prior periods. In line with the new business growth, all lines of business
showed satisfactory growth in gross inflows under management.
2002 2001
Rm Rm %
Health 4 314,9 3 340,5 29
Vitality 139,5 111,4 25
Life 196,2 67,4 191
Destiny 158,1 27,7 471
4 808,7 3 547,0 36
Operating profit before investment income
- local operations
2002 2001 %
Rm Rm Increase
Health 180,6 141,4 28
Vitality 11,7 23,1 (49)
Life 20,2 (1,3) -
Profit from 212,5 163,2 30
local
operations
Ddiscovery Health
As explained, the resolution with the Council for Medical Schemes resulted in a
decrease in gross income. However, the increase in Discovery membership of 19,6%
to 1 255 797 (2001: 1 049 916) and the focused management of outflows, in
particular operating and administration expenses, resulted in the operating
profit before investment income increasing by 28%. The operating profit of
Discovery Health is weighted to the second half of the financial year as premium
increase anniversaries are on 1 January each year while salary increases only
happen on 1 July each year.
Discovery Life
Discovery Life`s new business growth, fuelled by the launch of the Integrator
product and expansion of the franchise network, resulted in Discovery Life
contributing an operating profit before investment income of R20,2m.
Discovery Vitality
As highlighted in the 2001 interim results, Vitality`s operating margin has
reduced as a result of an increase in benefit offerings.
Destiny Health
Destiny Health`s loss increased to R89,9m (2001: R53,7m). No tax relief is
available on the losses incurred and there is no deferral of acquisition costs
in Destiny Health. Destiny`s new business is now in line with expectations.
However, the increase in new business came later than expected. In addition,
overspend on infrastructure led to a financial result that fell short of
expectations.
The above culminated in operating profit before taxation from local operations
increasing 30% to R258,3m (2001: R198,3m) which translates into an increase in
earnings per share from local operations of 28% to 46c (2001: 36c). Net profit
attributable to ordinary shareholders increased to R90,9m (2001: R85,4m).
Investment income
Investment income earned by policyholders after 1 July 2002 is excluded from
investment income in the income statement. The investment income of R46,7m
reflected in the income statement as earned by shareholders for the six months
ended 31 December 2002, is directly comparable to R36,3m for 2001.
Headline earnings per share
Headline earnings per share is based on earning as follows:
December December June
R million 2002 2001 2002
Net profit 90,9 85,4 261,7
attributable to
ordinary shareholders
Adjusted for realised
profit on available
for
sale financial (4,8) (0,5) (3,9)
instruments
Headline earnings 86,1 84,9 257,8
after abnormal items
Adjusted for abnormal - - (44,5)
items after taxation
Headline earnings 86,1 84,9 213,3
before abnormal items
Balance sheet
The increase in the minority interest in the balance sheet is attributable to
preference shares issued by Destiny Health.
Policyholder liabilities and reserves are negative as a result of the individual
life policyholder liabilities, due to a significant increase in profitable new
business.
Cash flow statement
Operating activities of Discovery Health and Vitality generated R277,3m (2001:
R212,1m). After absorbing Destiny Health`s operating costs of R95,1m (2001:
R46,7m) and R155,3m (2001: R109,0m) in respect of Discovery Life`s operating
costs, Discovery generated cash of R26,9m (2001: R56,4m) before working capital
changes.
Accounting policies
The principal accounting policies and methods of computation followed in the
current year are consistent with those of the prior year with the exception of
the consolidation of the Discovery Holdings Share Incentive Trust in terms of
AC412 and the effect of the adoption of AC133. Where necessary comparative
figures have been regrouped or restated to conform with changes in presentation
in the current year classifications.
The interim financial statements comply with Statements of Generally Accepted
Accounting Practice. The interim financial statements were not audited.
In line with Discovery`s policy, no dividend has been declared.
Group balance sheet at 31 December 2002
December June
2002 2002
R million Unaudited Audited
Assets
Non-current assets 1 088,5 1 084,1
Fixed assets 220,3 194,4
Intangible assets 33,3 30,5
Investments
- Linked assets under
investment contracts 521,9 588,0
- Other 313,0 271,2
Current assets 769,4 896,8
Total assets 1 857,9 1 980,9
Equity and liabilities
Capital and reserves 993,7 940,6
Share capital and share premium 428,8 427,1
Reserves 564,9 513,5
Minority interest 329,8 184,0
Policyholder liabilities and (78,3) 129,7
reserves
Life policyholder liabilities (528,2) (342,7)
Health insurance durational and
AIDS reserves 176,1 139,1
Deferred acquisition costs (246,2) (245,7)
Linked liabilities under
investment contracts 520,0 579,0
Current liabilities 612,7 726,6
Total equity and liabilities 1 857,9 1 980,9
Group statement of gross inflows under management for the six months ended 31
December 2002
Six months Six months Year
ended ended ended
December December June
2002 2001 Change 2002
R million Unaudited Unaudited % Audited
Gross inflows under 4 808,7 3 547,0 36 7 733,7
management
Less: Medical 2 962,7 1 311,5 3 877,0
scheme
contributions
Less: Money market - 357,5 356,9
contributions
Gross income of 1 846,0 1 878,0 3 499,8
group
Group income statement for the six months ended 31 December 2002
Six Six months Year
months
ended ended ended
December December June
2002 2001 Change 2002
R million Unaudited Unaudited % Audited
Gross income of 1 846,0 1 878,0 3 499,8
group
Less: Reinsurance 110,3 158,7 210,7
premiums
Net income 1 735,7 1 719,3 3 289,1
Investment income 46,7 92,4 134,6
Income 1 782,4 1 811,7 3 423,7
Claims and 775,7 1 001,6 1 721,6
policyholder
benefits
Commissions 211,6 110,6 272,6
Operating and
administration
expenses 671,4 533,6 1 108,5
Vitality benefits 104,3 74,9 167,4
Net deferral of (0,5) (16,9) (41,4)
acquisition costs
Outgo 1 762,5 1 703,8 3 228,7
Transfer from
policyholder
liabilities and 148,5 36,7 154,6
reserves
To linked - (31,2) (25,7)
policyholder
liabilities
From life 185,5 120,3 260,1
policyholder
liabilities
To health insurance
durational
and AIDS reserves (37,0) (52,4) (79,8)
Operating profit 168,4 144,6 349,6
before taxation
Local operations 258,3 198,3 30 457,9
Foreign operations (89,9) (53,7) (108,3)
Abnormal items - - 63,5
Profit before 168,4 144,6 16 413,1
taxation
Taxation 77,5 59,2 151,4
- Operating profit 77,5 59,2 132,4
- Abnormal items - - 19,0
Net profit
attributable to
ordinary 90,9 85,4 261,7
shareholders
Local 180,8 139,1 370,0
Foreign (89,9) (53,7) (108,3)
Basic earnings per
share before
abnormal items
(cents)
- undiluted 23,1 22,1 55,8
- diluted 22,5 21,9 54,2
Basic earnings per
share after
abnormal items
(cents)
- undiluted 23,1 22,1 67,3
- diluted 22,5 21,9 65,3
Headline earnings
per share before
abnormal items
(cents)
- undiluted 21,9 22,0 54,8
- diluted 21,3 21,8 53,2
Headline earnings
per share after
abnormal items
(cents)
- undiluted 21,9 22,0 66,3
- diluted 21,3 21,8 64,3
Weighted number of
shares
in issue (000`s) 393 017 386 792 389 092
Diluted weighted
number
of shares (000`s) 404 675 389 314 400 750
Group cash flow statement for the six months ended 31 December 2002
December December June
2002 2001 2002
R million Unaudited Unaudited Audited
Operating profit before
working
capital changes 26,9 56,4 93,6
Health and Vitality 277,3 212,1 433,1
Life (155,3) (109,0) (246,4)
Destiny (95,1) (46,7) (93,1)
Working capital changes (103,6) 176,4 78,1
Cash generated from (76,7) 232,8 171,7
operations
Investment income 39,8 51,7 73,2
Taxation paid (110,3) (204,6) (212,8)
Cash flow from operating (147,2) 79,9 32,1
activities
Cash flow from investing (138,1) (98,1) (183,3)
activities
Cash flow from financing 145,4 116,8 114,2
activities
Net (decrease)/increase in
cash and
cash equivalents (139,9) 98,6 (37,0)
Cash and cash equivalents at
beginning of year 354,4 385,3 385,3
Effects of exchange rate
changes on
cash and cash equivalents (7,8) - 6,1
Cash and cash equivalents
at end of year 206,7 483,9 354,4
Group statement of changes in equity for the six months ended 31 December 2002
Share Share Investment Retained Translation
capital premium reserve earnings reserve Total
Group Rm Rm Rm Rm Rm Rm
unaudited
31 December
2001
Balance at 1 0,4 424,4 14,2 238,7 6,1 683,8
July 2001
Net profit 85,4 85,4
for the
period
Unrealised
gains on
investments 21,2 21,2
Translation
of foreign
subsidiary 5,8 5,8
Issue of * 2,3 2,3
capital
Balance at 31 0,4 426,7 35,4 324,1 11,9 798,5
December 2001
31 December
2002
Balance at 1 0,4 426,7 30,8 487,1 (15,1) 929,9
July 2002
Effect of
consolidation
of share 10,7 10,7
trust
Restated 0,4 426,7 30,8 497,8 (15,1) 940,6
balance
Net profit 90,9 90,9
for the
period
Dividends
paid to
Destiny
Health
preference
shareholders (2,1) (2,1)
Unrealised
losses on
investments (28,3) (28,3)
Translation
of foreign
subsidiary (9,1) (9,1)
Issue of * 1,7 1,7
capital
Balance at 31 0,4 428,4 2,5 586,6 (24,2) 993,7
December 2002
* Amount is share par value
Segmental information for the six months ended 31 December 2002
Health
United
South States
of
R million Africa America Life Vitality Total
New business
annualised
premium income 1 163,3 186,9 214,6 32,9 1 597,7
Gross inflows under
management 4 314,9 158,1 196,2 139,5 4 808,7
Gross income 1 381,9 128,4 196,2 139,5 1 846,0
Expenses, commissions
and claims (1 (216,5) (328,3 (127,8) (1 762,5)
089,9) )
Transfer (to)/from
policyholder
liabilities
and reserves (37,0) - 185,5 - 148,5
Operating profit
before
investment income 180,6 (90,8) 20,2 11,7 121,7
Investment income 0,9 46,7
Operating profit (89,9) 168,4
Increase/(decrease)
in
operating profit
before investment 28 >100 (49)
income (%)
for the six months
ended 31 December
2001
Health
United
South States
of
R million Africa America Life Vitality Total
New business
annualised
premium income 917,7 118,7 109,6 26,2 1 172,2
Gross inflows under
management 3 340,5 27,7 67,4 111,4 3 547,0
Gross income 1 676,9 22,3 67,4 111,4 1 878,0
Expenses, commissions
and claims (1 352,4) (82,5) (180,6 (88,3) (1 703,8)
)
Transfer (to)/from
policyholder
liabilities and (83,6) - 120,3 - 36,7
reserves
Operating profit
before
investment income 141,4 (54,9) (1,3) 23,1 108,3
Investment income 1,2 36,3
Operating profit (53,7) 144,6
Group consolidated embedded value statement for the six months ended 31 December
2002
At
31 December
2001
At (Illustrative,
31 December after
R million 2002 resolution(1))
Shareholders` Funds(2) 993,7 798,5
Plus: Destiny Health Inc. start- - 146,5
up cost(3)
Less: Adjustment for DAC and (393,0) (337,6)
deferred commission(4)
Adjusted shareholders` funds 600,7 607,4
Value of in-force business before 3 202,8 2 384,3
cost of capital
Cost of capital (192,1) (82,9)
Discovery Holdings embedded value 3 611,4 2 908,8
Number of shares (millions) 397,8 390,6
Embedded value per share (Rands) 9,08 7,45
Diluted embedded value per share 8,82 7,39
(Rands)
Embedded value per share 9,56 7,71
excluding shares issued to the
Discovery Holdings Share
Incentive Trust (Rands)(2)
At
Change 31 December At 30
June
% 2001 2002
798,5 940,6
146,5 -
(337,6) (390,4)
607,4 550,2
34 3 131,5 2 820,2
(115,6) (164,8)
24 3 623,3 3 205,6
390,6 390,6
22 9,28 8,21
9,22 7,98
9,60 8,51
(1) Values for 31 December 2001 were restated for illustrative purposes during
2002 to show the impact of the resolution between Discovery Health and the
Discovery Health Medical Scheme with the Council for Medical Schemes.
(2) The Discovery Holdings Share Incentive Trust was consolidated for the first
time in the results as at 31 December 2002. This has resulted in a decrease in
Shareholders` Funds. Comparative figures for prior periods have also been
restated. The embedded value per share has also been calculated excluding shares
issued to the Discovery Holdings Share Incentive Trust.
(3) Destiny Health is now being valued as excess assets over liabilities and the
discounted value of the expected future profits on the current block of
business, and is therefore included in each of the embedded value components
shown.
(4) The adjustment for the deferred acquisition cost (DAC) and deferred
commission assets was previously reflected in the value of in-force business.
VALUE OF IN-FORCE BUSINESS
Value Value
before after
cost of Cost of cost of
R million capital capital capital
Health, Vitality and Pre-funding 2 582,2 (110,8) 2 471,4
Life 556,8 (56,8) 500,0
Destiny Health 63,8 (24,5) 39,3
Total 3 202,8 (192,1) 3 010,7
EMBEDDED VALUE EARNINGS
Six months to
31 December
2001
Six months (Illustrative Six months 12 months
to , to to
31 December after 31 30 June
December
R million 2002 resolution) 2001 2002
Embedded value 3 611,4 2 908,8 3 623,3 3 205,6
at end of
period(1)
Embedded value 3 205,6 3 083,3 3 083,3 3 083,3
at beginning
of period(1)
Increase in 405,8 (174,5) 540,0 122,3
embedded value
Net capital 0,4 (2,3) (2,3) 0,3
raised
Impact of (10,7)
consolidation
of share
trust(1)
Adjustment for 2,6 11,2 11,2 64,0
DAC and
deferred
commission(2)
Embedded value 408,8 (165,6) 548,9 175,9
earnings
(1) The Discovery Holdings Share Incentive Trust was consolidated for the first
time in the results as at 31 December 2002. This has resulted in a decrease in
Shareholders` Funds. Comparative figures for prior periods have also been
restated.
(2) This adjustment to Shareholders` Funds relates to the increase in the DAC
and deferred commission assets over the period.
Components of Embedded Value Earnings
Six months to
31 December
2001
Six (Illustrative, Six 12
months months months
to to to
31 after Change 31 30 June
December December
R million 2002 resolution) % 2001 2002
Total profit 275,5 201,1 37 269,9 445,7
from new
business (at
point of
sale)
Profit from
existing
business
- Expected 241,3 197,6 197,6 374,3
return
- Change in (182,8) (725,6) (79,9) (934,8)
methodology
and
assumptions
- Experience 76,8 116,2 116,2 241,3
variances
Return on (2,0) 45,1 45,1 49,4
shareholders`
funds(1)
Embedded 408,8 (165,6) 548,9 175,9
value
earnings
(1) Return on shareholders` funds is the after-tax investment return.
Group consolidated embedded value statement (continued) for the six months ended
31 December 2002
Experience Variances for the six months ended 31 December
2002
R million 2002
Expenses (132,9)
Health, Vitality and Pre-funding renewal 2,3
expenses
Health, Vitality and Pre-funding acquisition (58,8)
expenses(1)
Life renewal expenses (3,0)
Destiny Health expenses(2) (73,4)
CPI increase 68,9
Extended modelling term(3) 52,5
Lapses 38,3
Health, Vitality and Pre-funding 37,4
Life 0,0
Destiny Health 0,9
Medical inflation 45,0
Life policy alterations 22,7
Exchange rate movements (14,2)
Life mortality and morbidity 7,2
Other (10,7)
Total 76,8
(1) An exceptionally high proportion of Health new business was written during
the period but only activated on 1 January 2003 - outside of the valuation
period. An experience variance arises in respect of the acquisition expenses
incurred for these members who are not included in the embedded value
calculation.
(2) The present value of future profits for Destiny Health assumes expenses in
line with long-term best estimates. Over the shorter term, due to the start-up
nature of Destiny Health, actual expenses may be higher than those assumed,
resulting in an experience variance. This experience variance may persist in the
short term.
(3) The projection term for Health, Vitality, Pre-funding and Destiny Health at
31 December 2002 has not been changed from that used at 30 June 2002. Thus, an
experience variance arises because the total term of the in-force business is
effectively increased by six months.
Methodology and Assumptions Changes for the six months ended 31 December 2002
R million 2002
Medical scheme contractual change (261,1)
Other modelling changes 38,9
Economic assumption changes 30,1
Health, Vitality and Pre-funding 8,6
Life 22,0
Destiny Health (0,5)
Renewal expenses 24,8
Health, Vitality and Pre-funding 26,3
Life (1,5)
Destiny Health 0,0
Mortality and morbidity (23,8)
Other 8,3
Total (182,8)
Embedded Value Of New Business
Six months to
31 December
2001
Six months (Illustrative,
to
31 December after
R million 2002 resolution)
Health and Vitality
Gross profit from new business at 76,5 119,8
point of sale
Cost of capital (6,3) (5,7)
Net profit from new business at point 70,2 114,1
of sale
New business annualised premium 459,8 943,9
income(1)
Life
Gross profit from new business at 218,6 99,2
point of sale
Cost of capital (20,3) (12,2)
Net profit from new business at point 198,3 87,0
of sale
New business annualised premium 188,8 109,6
income(2)
Destiny Health
Gross profit from new business at 16,0
point of sale
Cost of capital(3) (9,0)
Net profit from new business at point 7,0
of sale
New business annualised premium 186,9
income
Six months to 12 months to
Change 31 December 30 June
% 2001 2002
186,3 285,7
(9,9) (20,8)
(38) 176,4 264,9
(51) 943,9 1 868,7
99,2 206,5
(5,7) (43,8)
128 93,5 162,7
72 109,6 255,4
18,1
-
18,1
205,8
(1) Health new business annualised premium income is the gross medical scheme
contribution. New business annualised premium income of R1 196,2m was written
for Health and Vitality during the six-month period to 31 December 2002.
However, due to the high proportion of Health new business written during the
period but only activated on 1 January 2003 - outside of the valuation period -
new business annualised premium income for the six month period to 31 December
2002 has been adjusted to include only those new members included in the
embedded value calculation.
(2) Life new business annualised premium income is net of automatic premium
increases in respect of existing business.
(3) Destiny Health`s new business now adds to its capital requirements.
Previously, new business did not increase the minimum level of solvency capital
required in terms of US regulations.
EMBEDDED VALUE ASSUMPTIONS
31 December 31 December 30 June
2002 2001 2002
(%) (%) (%)
Risk discount rate
- Health and 16,00 16,50 17,25
Vitality
- Prefunding 14,00 15,00 15,25
- Life product 14,00 15,00 15,25
- Destiny Health 10,00 - 10,00
Medical inflation
South Africa 10,00 10,50 11,25
United States Decreases - 11,50
linearly
from 14,25%
in year 1 to
9,75% in
year 10
Expense inflation 7,00 8,00 8,25
Pretax investment
return
South Africa - Cash 9,50 - 10,75
- Bonds 11,00 11,50 12,25
- Equity 13,00 - 14,25
United States - Bonds 2,00 - 2,00
Income tax rate
- South Africa 30,00 30,00 30,00
- United States(1) 0,0 - 0,0
(1) Based on the projected utilisation of Destiny Health`s assessed tax loss to
date, it is assumed that no income tax will be payable over the projection term.
Embedded value commentary
The embedded value of Discovery at 31 December 2002 is calculated as the sum of
the following components:
- The excess assets over liabilities at the valuation date.
- The value of in-force business at the valuation date (less an allowance for
the cost of capital).
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.
The value of one year of new business is determined at the point of sale as 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.
Comparative figures are shown for the six months to 31 December 2001 and the
year to 30 June 2002. Values for 31 December 2001 were restated for illustrative
purposes during 2002 to show the impact of the resolution between Discovery
Health and the Discovery Health Medical Scheme with the Council for Medical
Schemes, as detailed in Discovery`s announcement dated 26 June 2002. The figures
for 30 June 2002 and 31 December 2002 similarly incorporate this agreement.
At 31 December 2001, an embedded value of R146,5m was placed on Destiny Health
based on the expenses incurred in establishing the business. The approach
adopted for the calculation of the 30 June and 31 December 2002 embedded value,
values Destiny Health on the same methodology as that used for the South African
operations, that is, by taking the sum of excess assets over liabilities and
discounted value of the expected future profits on the current block of
business, giving a value of in-force business after cost of capital of R39,3m.
The cost of capital has moved from a marginal to an average cost of capital
basis for Destiny Health`s new business.
The cost of capital has been calculated considering the capital needs of the
company, which are largely driven by the negative reserves of Discovery Life,
and the expected asset mix held to meet the Discovery group`s prescribed capital
requirements.
Tillinghast - Towers Perrin, the international consulting actuaries, have
reviewed the methodology and assumptions used to determine the value of current
business and the value of new business and have confirmed that, overall, they
are reasonable.
Directors
L L Dippenaar (Chairman), A Gore (Chief Executive Officer), J M Robertson (Chief
Operating Officer), B Swartzberg*, J P Burger, Dr N J Dlamini**,R B Gouws, M I
Hilkowitz, N S Koopowitz*, S R Maharaj, H P Mayers*, S V Zilwa+, S D Whyte*
*Executive ** Appointed 5 December 2002 +Appointed 20 February 2003
Transfer secretaries
Computershare Services Limited
(Registration number 1958/003546/06)
70 Marshall Street, Johannesburg, 2000
PO Box 61051, Marshalltown, 2107
Secretary and registered office
M J Botha
155 West Street, Sandton, 2146
PO Box 786722, Sandton, 2146
Tel: (011) 529 2888
Fax: (011) 529 2958
Discovery
e-mail questions to: AskTheCFO@discovery.co.za
Discovery Holdings Limited
(Registration number 1999/007789/06)
Share code: DSY
ISIN code: ZAE000022331
www.discovery.co.za
Date: 25/02/2003 09:00:10 AM Supplied by www.sharenet.co.za
Produced by the JSE SENS Department
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