| Mon 21 Feb 2005, 12:04 | | Interim Financial Results |
|
Discovery Holdings Limited
(Registration number 1999/007789/06)
Share code: DSY
ISIN code: ZAE000022331
Unaudited interim financial results
for the six months ended 31 December 2004
Highlights
Headline earnings +43%
Embedded value +27% to R8 billion
New business annualised premium income R2 billion for the six months
Gross inflows under management +21%
Destiny Health achieves overall profitability in January 2005
Discovery Life signs letter of intent with Prudential to market protection
products in UK
Introduction
Discovery's performance over the period was pleasing. Its established businesses
generated strong organic growth, while intense focus was applied to Discovery's
new businesses, yielding significant progress and creating platforms for future
growth.
Despite significant start-up costs associated with PruHealth and the Discovery-
Card, pre-tax profit increased by 36%, with diluted headline earnings per share
increasing by 35%. Annualised new business premium income grew by 34% to R1 957
million.
The Discovery business model is based on the concept of engaging consumers in
their health, enabling it to provide financial products that are efficient,
sustainable and appropriate. It is this simple idea of "making people healthier
and protecting their lifestyles" that underpins all of Discovery's businesses.
Importantly, this consumerism is a key emerging trend in most markets and
Discovery's experience in this regard places it in a uniquely competitive
position going forward. The six months under review reflect this competitiveness
and the ability to migrate the model to other markets.
Discovery Health
Discovery Health's performance was particularly pleasing over the period.
Discovery Health is resolutely committed to building a robust and efficient
private health care system consistent with Government policy. In this regard, it
must balance and align the needs of members and the health care system with its
corporate needs.
Its performance over the period demonstrates this ability clearly: Members of
the Discovery Health Medical Scheme entered 2005 with the lowest level of
medical contribution inflation ever, benefits were increased in key areas, and
remuneration for general practitioners and specialists was increased
significantly. The Discovery Health Medical Scheme generated a surplus of R1,4
billion over the period, increasing its reserve levels to R3,1 billion,
marginally missing the target of 25%. By January 2005, this target of R3,2
billion has now been exceeded.
Discovery Health's size, infrastructure and capabilities positioned it for
growth and efficiency. Annualised new business premium income to Discovery
Health increased 26% to R1 175 million (2003: R935 million). Operating profit
increased by 15% to R249 million (2003: R216 million), despite the
discontinuation of all reinsurance.
Discovery Life
Discovery Life's performance continues to exceed expectation. Operating profit
increased by 82% to R191 million (2003: R105 million), with annualised new
business production increasing 19% to R332 million (2003: R279 million). The
value of the in-force business increased by 73% to R1 641 million (2003: R946
million).
Discovery Life has established a leadership position within the pure life
assurance market. In the period under review it focused on continued innovation
and integration with Discovery Health and Vitality. Notably, the quality of
business written and the unfolding mortality and morbidity experience
significantly exceeded expectation, driving profitability and embedded value.
The integration strategy has proved remarkably successful with 94% of those
eligible, opting for the "Integrator" version of the Discovery Life Plan. Early,
but strong evidence is beginning to emerge, which illustrates the positive
correlation between Vitality membership and better mortality and morbidity
experience. This clearly bodes well for future growth and profitability.
Based on Discovery Life's product technology and infrastructure, a letter of
intent has been signed with the Prudential Assurance Company Limited, a wholly-
owned subsidiary of Prudential plc, for the development and marketing of
protection products in the United Kingdom using Discovery's product and
administration strengths. The products will be marketed under the Prudential
brand, and will be distributed through Prudential's existing sales channels.
Destiny Health
Destiny's performance exceeded expectation. The company had the stated intention
of generating an overall profit across all its markets by the end of 2004. This
goal was set after Destiny generated a profit in Illinois, its initial market,
early in 2004.
To this end, annualised new business increased over the period under review by
84% to R409 million (2003: R222 million). Membership crossed the stated and
important target of 50 000 lives and operating losses for the period decreased
by 51% to R39 million (2003: R79 million). A maiden operating profit of R1,6
million was generated in January 2005.
Significant progress was made with Destiny's joint venture partners:
* The joint venture with the Guardian Life Insurance Company is performing ahead
of expectation. Increasing success is being achieved in the Illinois market and
during the period, the company successfully expanded into the Washington DC-
Virginia-Maryland market. Early progress in this new market has exceeded
expectation.
* While the initial progress in Massachusetts with the Tufts Health Plan was
slow, significantly more traction was achieved during the period with new
business production more in line with that budgeted.
Overall, Destiny is now well placed in three important markets and is now
evaluating a further expansion market for late 2005. A platform for growth has
been established with considerable focus now being applied to increase the
distribution scale and intensity in these markets.
The performance of the company's products has exceeded expectation and
operationally, the company has performed well. The move of back-office
functionality to South Africa was accelerated during the period, providing the
company with competitive advantage both functionally and in terms of cost. More
than 200 people now serve Destiny from South Africa.
PruHealth
During the period, PruHealth was successfully launched into the UK private
medical insurance market. The start-up costs amounted to R80 million over the
period, in line with the budget set.
By the end of the period under review - three months from its launch -
approximately 1 800 lives were covered. Going forward, the company is well
positioned for strong growth and significant overall potential:
* The product construct and its Vitality chassis has been received particularly
well by press and brokers. Its structure and approach is consistent with UK
Government health policy of now focusing on making people healthier.
* Recent research illustrates the success of PruHealth's positioning. The
company's brand awareness amongst consumers rivals that of its major
competitors, AXA PPP, Standard Life and Norwich Union - reflecting the powerful
brand platform provided by the Prudential plc.
* The infrastructure built is significant, utilising the back-office
capabilities of Discovery. The platform built is now ready to support
significant growth going forward.
The focus in the short-term is on building the distribution capabilities so that
the significant potential within PruHealth can be realised.
Vitality and Discovery Card
Vitality continues to play a foundational role in all of Discovery's businesses
and is the embodiment of Discovery's vision of making people healthier. The
marked and positive impact of Vitality on morbidity and mortality is becoming
statistically clear and strongly supports the Discovery strategy of intense
focus in this area.
In the period under review operating profit reduced by 55% to R9 million (2003:
R20 million). This was caused by the enhancement of certain key Vitality
benefits and the significant investment in the development and rolling out of
the DiscoveryCard, Discovery's new generation credit card. The combined positive
knock-on effect elsewhere within Discovery will more than compensate for this
going forward, and it is expected that the Vitality profit levels will return to
and grow off previous levels.
The launch of DiscoveryCard during the period was particularly successful, with
over 60 000 cards purchased in just the first three months. However, the
combination of significant sales, the chosen courier delivery system and the
onerous documentation requirements of the Financial Intelligence Centre Act
(FICA) created significant delivery bottlenecks. This has largely been addressed
and it is anticipated that card sales will continue to grow significantly,
providing a foundation for an intensifying of Discovery's drive to incentivise
better health.
Prospects
All of Discovery's businesses are well positioned for strong growth going
forward without requiring recourse to additional capital.
By order of the board
LL Dippenaar A Gore
Chairman Chief Executive Officer
17 February 2005
Directors
LL Dippenaar (Chairman), A Gore (Chief Executive Officer), JM Robertson, (Chief
Operating Officer), Dr BA Brink, JP Burger, Dr NJ Dlamini, SB Epstein(USA)**, MI
Hilkowitz, NS Koopowitz*, HP Mayers*, B Swartzberg*, SV Zilwa, SD Whyte*
*Executive **Appointed 17 February 2005
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) Corporate Finance
Secretary and registered office
MJ Botha
155 West Street, Discovery Holdings Limited
Sandton, 2146
PO Box 786722, (Registration number 1999/007789/06)
Sandton, 2146
Tel: (011) 529 2888 Share code: DSY
Fax: (011) 529 2958 ISIN code: ZAE000022331
Income statement
for the six months ended 31 December 2004
Group Group Group
Six Six Year
months months
ended ended ended
December December June
2004 2003 % 2004
R million Unaudited Unaudited change Audited
Gross income of group 1 840 2 021 3 698
Outward reinsurance (145) (168) (293)
premiums
Net income 1 695 1 853 3 405
Policyholder benefits (370) (796) (1 078)
Recoveries from 99 138 237
reinsurers
Net policyholder (271) (658) (841)
benefits
Commissions (363) (279) (576)
Operating and (837) (787) (1 495)
administration
expenses
Vitality benefits (190) (144) (314)
Transfer from 296 277 529
assets/liabilities
arising from
insurance contracts
Profit from 330 262 26 708
operations
Local operations 449 341 842
Foreign operations (119) (79) (134)
Investment income 85 70 124
Realised and 82 52 68
unrealised investment
gains
Fair value adjustment (91) (60) (71)
to liabilities
arising from
investment contracts
Financing costs (23) (31) (47)
Foreign exchange loss (33) (36) (62)
- unrealised
Profit before 350 257 36 720
taxation
Taxation (144) (123) (299)
Profit after taxation 206 134 54 421
Minority share of - 1 (3)
loss
Net profit 206 135 53 418
attributable to
ordinary shareholders
Earnings per share
(cents)
- undiluted 39.7 27.3 45 83.0
- diluted 38.5 26.6 45 79.7
Headline earnings per
share (cents)
- undiluted 36.7 27.1 35 80.5
- diluted 35.7 26.4 35 77.4
Weighted number of 518 793 494 914 504 051
shares in issue
(000's)
Diluted weighted 549 271 526 922 536 025
number of shares
(000's)
Headline earnings
Net profit 206 135 418
attributable to
ordinary shareholders
Adjusted for realised (15) (1) (13)
profit on available-
for-sale financial
instruments
Headline earnings 191 134 43 405
Balance sheet
at 31 December 2004
Group Group
December June
2004 2004
R million Unaudited Audited
ASSETS
Cash and cash equivalents 1 186 998
Government and public authority stocks
- available-for-sale 135 130
- at fair value through profit and loss 51 52
Equity investments
- available-for-sale 801 602
- at fair value through profit and loss 322 251
Investment in associate 3 2
Investment assets 2 498 2 035
Loans and receivables 438 430
Taxation 17 -
Deferred taxation 10 10
Assets arising from insurance contracts 1 615 1 318
Intangible assets 42 38
Equipment 183 201
Total assets 4 803 4 032
LIABILITIES AND SHAREHOLDERS' FUNDS
LIABILITIES
Current liabilities 739 578
Provisions 23 22
Taxation - 43
Deferred taxation 262 128
Liabilities arising from insurance 7 6
contracts
Liabilities arising from reinsurance 34 36
contracts
Financial liabilities 850 716
- Investment contracts at fair value 470 400
through profit and loss
- Borrowings at amortised cost 380 316
Total liabilities 1 915 1 529
Outside shareholders' interest 67 67
SHAREHOLDERS' FUNDS
Share capital and share premium 1 293 1 276
Reserves 1 528 1 160
Total shareholders' funds 2 821 2 436
Total liabilities and shareholders' 4 803 4 032
funds
Net asset value per share (cents) 542.4 474.6
Number of shares in issue (000's) 520 139 513 287
Cash flow statement
for the six months ended 31 December 2004
Group Group Group
Six Six Year
months months
ended ended ended
December December June
2004 2003 2004
R million Unaudited Unaudited Audited
Health 316 282 655
Life 80 (164) (248)
- operating activities (120) (164) (248)
- quota share deposit 200 - -
Vitality 15 22 62
Holdings - - (1)
Destiny (27) (82) (103)
PruHealth (77) - (28)
Cash generated by operations 307 58 337
Working capital changes (41) (62) (119)
266 (4) 218
Dividends received 11 5 14
Interest received 46 61 88
Interest paid (3) (16) (14)
Taxation paid (114) (132) (214)
Cash flow from operating 206 (86) 92
activities
Cash flow from investing (69) (363) (504)
activities
Investment purchases (111) (336) (565)
Proceeds on disposal of 91 40 176
investments
Purchase of equipment (36) (48) (93)
Purchase of intangible assets (16) (23) (26)
Decrease in loans receivable 3 4 4
Cash flow from financing 59 (28) (39)
activities
Proceeds from shares issued 18 878 878
Share issue costs written off (1) (28) (30)
against share capital
Dividends paid to Destiny - (2) (2)
Health preference
shareholders
Minority share buy-back (1) - (9)
Increase in borrowings 43 - -
Repayment of short-term loan - (876) (876)
Net increase/(decrease) in 196 (477) (451)
cash and cash equivalents
Cash and cash equivalents at 998 1 469 1 469
beginning of year
Effects of exchange rate (8) (48) (20)
changes on cash and cash
equivalents
Cash and cash equivalents at 1 186 944 998
end of year
Statement of changes in equity
for the six months ended 31 December 2004
Invest-
Share Share ment
R million capital premium reserve
31 December 2004
Balance at 1 July 1 1 275 51
2004
Issue of capital * 18 -
Share issue expenses - (1) -
Net profit for the - - -
period
Dividends paid to
Destiny
Health preference - - -
shareholders
Unrealised gains on - - 163
investments
Realised gains on - - (15)
investments
transferred to income
statement
Revaluation of - - -
forward foreign
exchange contract
Translation of - - -
foreign subsidiary
Balance at 31 1 1 292 199
December 2004
31 December 2003
Balance at 1 July 1 428 (4)
2003
Issue of capital * 877 -
Share issue expenses - (28) -
Net profit for the - - -
period
Unrealised gains on - - 75
investments
Realised gains on - - (1)
investments
transferred to income
statement
Revaluation of - - -
forward foreign
exchange contract
Translation of - - -
foreign subsidiary
Balance at 31 1 1 277 70
December 2003
* Amount is less than R500 000
Statement of changes in equity
for the six months ended 31 December 2004
Trans-
Retained lation Hedging
R million earnings reserve reserve Total
31 December 2004
Balance at 1 July 1 046 69 (6) 2 436
2004
Issue of capital - - - 18
Share issue expenses - - - (1)
Net profit for the 206 - - 206
period
Dividends paid to
Destiny
Health preference (1) - - (1)
shareholders
Unrealised gains on - - - 163
investments
Realised gains on - - - (15)
investments
transferred to
income statement
Revaluation of - - 6 6
forward foreign
exchange contract
Translation of - 9 - 9
foreign subsidiary
Balance at 31 1 251 78 - 2 821
December 2004
31 December 2003
Balance at 1 July 634 52 (14) 1 097
2003
Issue of capital - - - 877
Share issue expenses - - - (28)
Net profit for the 135 - - 135
period
Unrealised gains on - - - 75
investments
Realised gains on - - - (1)
investments
transferred to
income statement
Revaluation of - - 14 14
forward foreign
exchange contract
Translation of - 1 - 1
foreign subsidiary
Balance at 31 769 53 - 2 170
December 2003
* Amount is less than R500 000
Segmental information
for the six months ended 31 December 2004
Health
United
South States of United
R million Africa America Kingdom
31 December 2004
New business annualised 1 175 409 5
premium income
Income statement
Gross income 782 237 *
Reinsurance (2) (3) -
Net policyholder benefits (3) (171) *
Commissions - (20) *
Operating and (528) (82) (80)
administration expenses
Transfer from - - -
assets/liabilities under
insurance contracts
249 (39) (80)
Return on assets under - - -
insurance contracts
Profit/(loss) from 249 (39) (80)
operations
Investment income and
realised profits
Financing costs
Foreign exchange loss -
unrealised
Profit before taxation
31 December 2003
New business annualised 935 222 -
premium income
Income statement
Gross income 1 287 165 -
Reinsurance (44) (44) -
Net policyholder benefits (488) (82) -
Commissions - (9) -
Operating and (539) (109) -
administration expenses
Transfer from - - -
assets/liabilities under
insurance contracts
216 (79) -
Return on assets under - - -
insurance contracts
Profit/(loss) from 216 (79) -
operations
Investment income and
realised profits
Financing costs
Foreign exchange loss -
unrealised
Profit before taxation
Amount is less than R500 000
Segmental information
for the six months ended 31 December 2004
R million Life Vitality Total
31 December 2004
New business annualised 332 36 1 957
premium income
Income statement
Gross income 587 234 1 840
Reinsurance (140) - (145)
Net policyholder benefits (97) - (271)
Commissions (325) (18) (363)
Operating and (130) (207) (1 027)
administration expenses
Transfer from 232 - 232
assets/liabilities under
insurance contracts
127 9 266
Return on assets under 64 - 64
insurance contracts
Profit/(loss) from 191 9 330
operations
Investment income and 76
realised profits
Financing costs (23)
Foreign exchange loss - (33)
unrealised
Profit before taxation 350
31 December 2003
New business annualised 279 26 1 462
premium income
Income statement
Gross income 384 185 2 021
Reinsurance (80) - (168)
Net policyholder benefits (88) - (658)
Commissions (260) (10) (279)
Operating and (128) (155) (931)
administration expenses
Transfer from 234 - 234
assets/liabilities under
insurance contracts
62 20 219
Return on assets under 43 - 43
insurance contracts
Profit/(loss) from 105 20 262
operations
Investment income and 62
realised profits
Financing costs (31)
Foreign exchange loss - (36)
unrealised
Profit before taxation 257
Amount is less than R500 000
Embedded value statement
for the six months ended 31 December 2004
Group embedded value at 31 December 2004
Group Group Group
31 31 % 30 June
December December
R million 2004 2003 change 2004
Shareholders' funds 2 821(1) 2 170(2) 30 2 436
Value of in-force 5 604 4 402 27 4 803
business before cost
of capital
Cost of capital (434) (290) 50 (363)
Discovery Holdings 7 991 6 282 27 6 876
embedded value
Number of shares 520,1 513,5 513,3
(millions)
Embedded value per R15,36 R12,23 26 R13,40
share
Diluted embedded R14,71 R11,67 26 R12,89
value per share
(1) Shareholders' funds include R1 605 million in respect of the Life product
negative reserve.
Destiny Health preference shares were converted at R14/US$1 during 2003 and not
at historical rates of R7/US$1, in accordance with the Group's accounting
policy. As described in the 2004 Annual Report, the 31 December 2003
shareholders' funds balance was restated to record the preference shares at
historical rates. The effect of this restatement was to increase the currency
translation reserve by R60 million and reduce outside shareholders' interest by
R60 million.
Value of in-force business at 31 December 2004
Value Value
before Cost after
cost of of cost of
R million capital capital capital
Health and Vitality 3 329 -(1) 3 329
Life 2 062 (421) 1 641
Destiny Health (2) 213 (13) 200
Total 5 604 (434) 5 170
(1) With effect from 1 January 2004, no allowance has been made for the
inclusion in the Health value of in-force of any reinsurance contracts and the
cost of capital associated with such contracts.
(2) Figures for Destiny Health reflect Discovery's 99,2% shareholding in
Destiny Health at 31 December 2004.
Value of in-force business at 30 June 2004
Value Value
before Cost after
cost of of cost of
R million capital capital capital
Health and Vitality 3 194 - 3 194
Life 1 447 (340) 1 107
Destiny Health 162 (23) 139
Total 4 803 (363) 4 440
Embedded value earnings
Six months Six Twelve
months months
ended ended ended
31 December 31 30 June
December
R million 2004 2003 2004
Embedded value at end of 7 991 6 282 6 876
period
Embedded value at 6 876 4 928 4 928
beginning of period
Increase in embedded 1 115 1 354 1 948
value
Net issue of capital (17) (849) (847)
Dividends paid to Destiny 1 1 1
Health preference
shareholders
Revaluation of forward (6) (14) (8)
foreign exchange contract
Embedded value earnings 1 093 492 1 094
Annualised return on 34,3 20,9 22,2
embedded value (%)
Components of embedded value earnings
Six Six Twelve
months months months
ended ended ended
31 31 % 30
December December June
R million 2004 2003 change 2004
Total profit from new 375 358 5 637
business (at point of
sale)
Profit from existing
business
* Expected return 286 272 534
* Change in 315 (262) (361)
methodology and
assumptions (1)
* Experience variances 56 60 230
Acquisition costs (2) (60) (40) (5)
PruHealth start-up (64) - (28)
costs
Adjustment for 1 4 (4)
minority interest in
Destiny Health
Adjustment for
Guardian profit share
in
Destiny Health (3) (9) - (8)
Foreign exchange rate (38) (13) (67)
movements
Interest on loan (20) (25) (41)
capital
Return on 251 138 207
shareholders' funds
(4)
Embedded value 1 093 492 1 094
earnings
(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 the table below (for previous periods refer to previous embedded
value statements).
(2) A large proportion of Health and Vitality new business was written over the
period but only activated on 1 January 2005. Acquisition costs of R37 million
(December 2003: R30 million) arise in respect of these members who are not
included in the embedded value calculation. Similarly acquisition costs of R15
million (December 2003: R10 million) arise for Destiny Health. Life acquisition
costs of R8 million relate to commission paid in respect of new business that
was not yet on risk at 31 December 2004.
(3) In terms of the agreement between Destiny Health and the Guardian Life
Insurance Company of America, Guardian will share in 50% of the profits from
Destiny's non-alliance business once the business written by Guardian reaches
the contractual new member threshold. This is modelled to occur in June 2007.
Based on Guardian's progress at 31 December 2004 towards achieving this target,
the value attributed to Destiny's non-alliance business from 30 June 2007 has
been reduced by 13,7% (June 2004: 6,8%) in the embedded value calculation.
(4) Return on shareholders' funds is the investment return on shareholders'
funds after tax and management charges. Shareholders' funds include the Life
product's negative reserve.
Methodology and assumption changes for the six months ended 31 December 2004
Health
and Destiny
R million Vitality Health Life Total
Modelling changes - (23) 19 (4)
Quota share - 22 - 22
Lapses (1) 14 4 (4) 14
Economic assumptions (2) 35 13 73 121
Expenses (3) 160 35 6 201
Mortality and morbidity - (5) 8 3
Benefit enhancements (4) (72) - (2) (74)
Premium increase - (15) - (15)
Regulatory change (5) - - 99 99
Tax (6) (55) - - (55)
Other - 3 (0) 3
Total 82 34 199 315
(1) The Life lapse assumption change is in respect of Health Plan Protector
policies.
(2) The Life economic assumptions change includes a higher cancellation rate on
contribution increases which has been changed to be consistent with the current
lower inflationary environment. The impact of this change was a negative R57
million. The impact of the 1,5% reduction in the economic assumptions is
positive R124 million.
(3) The Health and Vitality renewal expense assumption change is based on the
results of the most recent expense analysis (31 December 2004). For Health and
Vitality, the actual experience reflects efficiencies achieved in managing the
Health business. The Destiny Health renewal expense assumption has been adjusted
to allow for the expected growth in membership over the next 12 months.
(4) The Health and Vitality assumption change includes an allowance for the
expected cost of benefit enhancements on Vitality.
(5) This represents the value to shareholders of the deferment of tax. A
deferred tax liability has been set up that is explained in the balance sheet
section of the financial commentary.
(6) The tax assumption change reflects a higher average VAT rate modelled.
Experience variances for the six months ended 31 December 2004
Health
and Destiny
R million Vitality Health Life Total
Renewal expenses 7 9 2 18
Non-recurring expenses (15) (3) - (18)
(1)
Inflation (2) (102) - 6 (96)
Extended modelling term 74 6 1 81
(3)
Lapses (4) 62 (14) (10) 38
Policy alterations 3 2 37 42
Mortality and morbidity - (34) 33 (1)
(5)
Quota share (6) - - (7) (7)
Premium increase - 5 - 5
Reinsurance - - (2) (2)
Other (8) 9 (5) (4)
Total 21 (20) 55 56
(1) The non-recurring expenses for Health and Vitality relate to both the
launch of the DiscoveryCard as well as costs relating to the discontinuation of
the Corporate Funder benefit. For Destiny Health, non-recurring expenses are in
respect of restructuring costs as well as costs relating to the recruitment of
an executive director.
(2) The negative variance for Health and Vitality is due to a lower 2005
increase (ie 4,2%) in the Health administration and managed care fees compared
with that assumed in June 2004 (ie 5,5%).
(3) The projection term for Health, Vitality, Destiny Health and Group Life at
31 December 2004 has not been changed from that used at 30 June 2004. Thus, an
experience variance arises because the total term of the in-force business is
effectively increased by six months.
(4) Included in the Health and Vitality lapse experience variance is an amount
of R131 million in respect of members joining existing employer groups during
the period.
(5) The Life mortality and morbidity variance is net of reinsurance.
(6) The impact of implementing the new quota share agreement was negative R7
million. This, however, excludes investment return of R5 million earned on the
assets received.
Embedded value of new business
Six Six Twelve
months months months
ended ended ended
31 31 % 30 June
December December
R million 2004 2003 change 2004
Health and Vitality
Gross profit from 67 43 155
new business at
point of sale
Cost of capital - - -
Net profit from new 67 43 56 155
business at point of
sale
New business 424 460 (8) 1 834
annualised premium
income (1)
Life
Gross profit from 369 370 583
new business at
point of sale
Cost of capital (78) (63) (131)
Net profit from new 291 307 (5) 452
business at point of
sale (2)
New business 245 214 14 406
annualised premium
income (3)
Annualised profit 14,3 12,1 13,3
margin (4) (%)
Destiny Health
Gross profit from 17 15 36
new business at
point of sale
Cost of capital (0) (7) (6)
(5)
Net profit from new 17 8 113 30
business at point of
sale (6)
New business 250 137 82 378
annualised premium
income (1)
New business 41 19 116 56
annualised premium
income (US$ million)
(1) Health and Destiny Health new business annualised premium income is the
gross medical contribution. For embedded value purposes, Health and Destiny
Health new business is defined as 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 31 December 2004.
The total Health and Vitality new business annualised premium income written
over the period was R1 211 million (December 2003: R961 million). For Destiny
Health, the total new business annualised premium income written over the period
was R409 million (December 2003: R222 million).
(2) The Life value of new business includes R22 million in respect of the value
to shareholders of the deferment of tax. A deferred tax liability has been set
up that is explained in the balance sheet section of the financial commentary.
(3) Life new business annualised premium income of R245 million shown above is
net of 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 R42 million and
servicing increases of R45 million was R332 million.
(4) The annualised profit margin is the value of new business expressed as a
percentage of the present value of future premiums. The majority of policies
sold under the Life product have accelerated premiums, ie premiums that increase
over the term of the policies, hence expressing the value of new business as a
percentage of the current new business premium, 118,8% (December 2003: 143,5%),
would overstate the annualised profit margin.
(5) As most of the new business is written on the Guardian and Tufts insurance
licences, Destiny Health is not required to hold statutory capital for this
business. An explicit charge for the use of their capital is payable to Guardian
and Tufts, and this cost is included in the gross profit from new business.
(6) The Destiny Health value of new business allows for the actual new business
expenses incurred over the six month period. No allowance for acquisition cost
efficiencies which are expected to occur as a result of strong membership growth
during 2005 has been made.
Embedded value assumptions
31 December 31 December 30 June
% 2004 2003 2004
Risk discount rate
- Health and 11,00 13,50 12,50
Vitality
- Life product 11,00 12,50 12,50
- Destiny Health 10,00 10,00 10,00
Medical inflation
South Africa 7,00 8,50 8,50
United States Current Current Current
levels levels levels
reducing to reducing to reducing to
12,50 over 11,50 over 12,50 over
the the the
projection projection projection
period period period
Expense inflation
South Africa 4,00 5,50 5,50
United States 3,00 5,00 5,00
Pre-tax investment
return
South Africa - 6,50 8,00 8,00
Cash
- Bonds 8,00 9,50 9,50
- Equity 10,00 11,50 11,50
United States - 2,00 2,00 2,00
Bonds
Income tax rate
- South Africa 30,00 30,00 30,00
- United States 34,00 34,00 34,00
Federal Tax Rate
(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.
Renewal expense assumptions were based on the results of the latest expense and
budget information.
The Health lapse assumptions were based on the results of recent experience
investigations. Renewal expense assumptions were based on the results of the
latest expense investigation.
The Destiny Health morbidity and lapse assumptions were based on the results of
recent experience investigations as well as future expectations regarding
premium increases.
The renewal expense assumption was based on the results of the latest expense
investigation and allows for the expected growth in membership over the next 12
months.
The investment return assumption was determined with reference to the cashflow-
weighted average risk-free yield curve. Other economic assumptions were set
relative to this yield.
It was assumed that the capital adequacy requirements in future years will be
backed by surplus assets consisting of 70% equities and 30% fixed interest
securities 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.
The embedded value of Discovery at 31 December 2004 is calculated as the sum of
the following components:
* The excess assets over liabilities at the valuation date, and
* 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 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.
PricewaterhouseCoopers Inc. has reviewed the methodology and assumptions used to
determine the value of in-force business and the value of new business and have
confirmed that, overall, they are reasonable.
Financial commentary
Review of group results
Gross inflows under management, excluding reinsurance premiums received from the
Discovery Health Medical Scheme ("DHMS"), increased 30% for the six months ended
31 December 2004. Gross inflows under management includes flows of the schemes
Discovery administers and business conducted together with its joint venture
partners. The increase is pleasingly driven by growth in all business areas,
with new business API increasing by a strong 34% to R1 957 million (2003: R1 462
million).
December December June
2004 2003 % 2004
Gross inflows R million R million Change R million
under management
SA Health 6 884 5 877 17 12 549
operations
Life operations 587 384 53 859
Vitality 234 185 27 403
operations
Destiny operations 375 234 60 554
Gross inflows 8 080 6 680 21 14 365
under management
Less: collected on (6 219) (4 652) (10 647)
behalf of third
parties
Gross income of 1 861 2 028 3 718
group
Less: DHMS - (596) (596)
reinsurance
premiums
1 861 1 432 30 3 122
Earnings
Discovery achieved an increase of 43% in headline earnings. Unrealised gains of
R148 million on available-for-sale investments for the period have been taken
directly to reserves and are not included in earnings or headline earnings.
The following table shows the main components of the increase in group operating
profit for the six months:
December December
2004 2003 %
Earnings source R million R million Change
SA Health operations 249 216 15
Life operations 191 105 82
Vitality operations 9 20 (55)
Destiny operations (39) (79) 51
UK set-up costs (80) - -
Group operating profit 330 262 26
The operating profit of Discovery is weighted to the second half of the
financial year as premium increase anniversaries are on 1 January each year
while salary increases occur on 1 July each year. In addition, significant new
business is activated effective 1 January each year.
Discovery Health
Discovery Health increased operating profits by 15% to R249 million (2003: R216
million). This strong financial performance is attributable to a growth in
membership under administration of 9% to 1 640 151 lives (2003: 1 505 896
lives), coupled with administration efficiencies.
With effect from 1 January 2004, DHMS was no longer reinsured by Discovery.
Discovery Life
Discovery Life's profits increased by 82% to R191 million (2003: R105 million)
and new business annualised premium income increased to R332 million (2003: R279
million), generating significant value. The number of individual policyholders
grew by 50% to 150 411 (2003: 100 218). Group lives covered increased to 53 858
(2003: 34 968).
Destiny Health
In the six months to 31 December 2004, the group incurred a foreign exchange
loss of R33 million on the rand denominated borrowings made by Destiny Health.
This loss was caused by the strengthening of the rand against the dollar from
R6,18/US$1 to R5,63/US$1 over the six month period.
On 31 December 2004, Discovery Holdings invested US$61 million into Destiny
Health. These funds were used by Destiny to redeem the rand denominated
borrowings on 18 January 2005.
PruHealth
Start-up costs of R80 million were incurred for the six month period under
review. In September 2004, Discovery invested GBP15 million into PruHealth to
meet its capital requirements. An additional GBP5 million was invested in
January 2005.
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.
An asset has been raised in loans and receivables on 50% of the PruHealth losses
for which group tax relief is available to Prudential plc in the UK. No deferred
tax asset has been accounted for on the balance of the PruHealth losses.
Balance sheet
Included in cash and cash equivalents is R200 million received in terms of a
quota share agreement entered into by Discovery Life with effect from 1 July
2004 which effectively reinsures 50% of the risk profits on certain classes of
business in-force as at 31 December 2003 for a period of approximately six
years. We previously considered that this amount would be included in income in
the current period. In line with recent developments in revenue recognition
principles, the profits will be recognised as they are earned. R32 million has
been recognised in income for the six months ended 31 December 2004 and the
balance has been included in current liabilities.
Investments have increased due to the strong performance of the equity markets.
The increase in the assets under insurance contracts of R296 million is as a
result of the significant increase in profitable new business written by
Discovery Life.
The deferred tax liability is primarily attributable to the application of the
FSB directive 145. This directive allows for the zeroing of the negative life
reserve on a statutory basis. 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. This is disclosed as a regulatory change in the
embedded value statement.
The minority interest of R67 million in the balance sheet comprises the Series A
preference shares of Destiny Health.
The first tranche of Discovery Life preference shares was redeemed, by agreement
with the preference shareholders, on 31 August 2004 resulting in the issue of 4
270 530 Discovery Holdings shares. Discovery Holdings issued a further 8 000 000
shares to the Share Incentive Trust in September 2004.
Accounting policies
The accounting policies applied are in accordance with South African Statements
of Generally Accepted Accounting Practice. These accounting policies are
consistent with those of the prior year.
Dividend policy
The directors have recommended that no dividend be paid at this time.
Comparative figures
Comparative figures have been restated where necessary to afford a more
meaningful comparison with the current year's figures in the following
instances:
* As disclosed at 30 June 2004, money market instruments in the investment
portfolios, previously included in investments, have been reclassified as cash
and cash equivalents in the 31 December 2003 comparatives.
* In line with industry practice, automatic premium increases have been excluded
from the new business annualised premium income for the Group Life business.
This has effectively reduced new business annualised premium income for the Life
business segment in the Segmental information for the six months ended 31
December 2003, from R290 million to R279 million.
Discovery
e-mail questions to: AskTheCFO@discovery.co.za
www.discovery.co.za/investor
Date: 21/02/2005 11:00:19 AM Produced by the JSE SENS Department
