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DSY
DSY
Discovery Holdings Limited - Audited results for the year ended
30 June 2006 and dividend declaration
Discovery Holdings Limited
(Incorporated in the Republlic of South Africa)
(Registration number: 1999/007789/06)
JSE share code: DSY
ISIN: ZAE000022331
Audited results for the year ended 30 June 2006
- Operating profit (before BEE exspenses) +37% to R1,3 billion
- Net profit after tax (before BEE expenses) +51% to R827 million
- Diluted HEPS (before BEE expenses) +34% to 126,4 cents per share
- New business annualised premium income +3% to R4,5 billion
- Maiden dividend of 27c per share declared
Introduction
The year under review has been a successful one for Discovery, with
important developments in each of its businesses, strong earnings growth
and the declaration of a maiden dividend. The Group"s core purpose of
"making people healthier and enhancing and protecting their lives" imposes
an ethos wherein always meeting clients" needs first and foremost leads to
superior growth and profitability. The year under review illustrates the
continued efficacy of this approach. As in previous years, all of
Discovery"s businesses focused intensely on significant developments and
innovations designed to meet specific client needs in rapidly changing
markets - resulting in strong organic growth.
Discovery has consistently followed a philosophy of pursuing organic
growth, funded from internal resources without recourse to debt. Discovery
is now in a position of having built both scale and platforms for future
growth, but is now concurrently strongly cash-generative. Discovery Life"s
significant growth since its commencement in 2001 required substantial
investment of the Group"s cash resources. The company is now turning
cashflow-positive and so, while Discovery will continue to pursue
aggressively a wide range of new initiatives, the Group is expected to be
cash-generative going forward. The level of the maiden dividend has been
set taking into account Discovery"s future capital and growth needs.
Discovery Life
Discovery Life"s performance exceeded expectation. The core driver of
Discovery Life"s performance is the leadership position that it has
achieved in the protection market. Discovery"s ethos of focusing on
clients" needs first has translated into a strategy that leads to both
growth and profitability. The key success factors in this market are price
competitiveness and product innovation, which lead to growth, superior
mortality and morbidity experience and higher levels of persistency. During
the year, the launch of the Discovery Life Card Integrator, which
integrates the DiscoveryCard with the Discovery LIFE PLAN in order to
achieve lower premiums, was a further step in using Discovery"s unique
product platform to generate value for clients, while creating a strong
product differentiation. A substantial portion of Discovery Life"s
profitability was generated from mortality and morbidity profits,
illustrating the success of the strategies followed.
The significant embedded value of the new business transacted, combined
with the positive experience variances of the in-force embedded value,
reflect the quality and scale of the company"s protection business.
During the year, Discovery Life entered the retirement funding market with
the launch of the Discovery retirement Optimiser. While still early in its
evolution, the company estimates that its market share of new business
amounted to approximately 17% of the independent broker recurring premium
Retirement Annuity market, in just its first year of entry. Given this,
Discovery Life is evaluating a broader long-term savings offering.
Discovery Life"s joint protection initiative with the Prudential plc was
launched into the UK assurance market during July 2006. The strategy
followed was a controlled roll-out to select broker houses to ensure that
both Discovery Life and the Prudential could gain a deep and rapid insight
into the dynamics of the market to ensure success, given the fundamental
differences to existing products that the joint protection product
represents. While early signs are positive, Discovery Life remains
cautiously optimistic for the prospects of this initiative. The financial
structure of the joint venture requires limited capital for infrastructural
development from Discovery, but exposes Discovery to the upside of the
embedded value created.
Discovery Health
Discovery Health"s performance was pleasing. Operating profit increased by
20% to R655 million (2005: R548 million) and the number of lives covered on
the Discovery Health Medical Scheme and other medical schemes under
management increased by 8% to R1,94 million from 1,78 million.
Discovery Health"s purpose is clear: to create affordable access to quality
healthcare on a sustainable basis for its clients. It is uniquely
positioned to do so due its size and unique assets. The size of the DMHS is
now 3,8 times greater than that of its nearest competitor, and just this
year"s growth is larger than the fourth largest medical scheme in the
market.
During the year under review, considerable progress was made in discussions
with hospital and other provider groups toward the managing of healthcare
costs, which continue to increase at stubbornly high medical inflation
rates, despite a lower price inflation environment. The company is close to
launching a series of provider initiatives aimed at providing quality care
at affordable and sustainable rates, while ensuring members" service
experience is positive and effortless. It is anticipated that these
developments will benefit members directly and will further serve to
entrench Discovery Health"s competitive position, enabling future growth.
The company continued its growth in the lower income market through its
KeyCare product range and to this end formed a proprietary network of 2 055
doctors and 64 hospitals specifically to care for KeyCare members.
Considerable investment in operations and technology was made in the
previous year, and this yielded substantial results during the year under
review. Discovery Health"s business is of a highly transactional nature,
with large volumes of administrative transactions taking place every day.
In this context, the implementation of a small number of well-executed
initiatives can have a significant impact. Service levels reached their
highest levels yet, and importantly substantial efficiencies emerged, with
staff headcount per thousand lives covered reducing by 13,2% over the year.
The combination of organic growth and expense efficiencies drove the
increase in operating profit.
Destiny Health
Destiny Health"s performance was disappointing for the financial year,
although its performance for the last six months was in line with
expectations set at the interim results stage. Operating losses increased
by 68% to R151 million (2005: R90 million) and recurring premium new
business reduced by 2% to R796 million (2005: R809 million).
The poor performance reflects a significant shift in the competitive
dynamics of the markets in which Destiny operates. While the concept of
Consumer-Driven Healthcare continues to grow significantly in the US health
insurance markets - presenting a substantial and unique opportunity for
Discovery given the Group"s experience and capabilities - it became clear
during the first six months of the year that Destiny was poorly positioned
to make positive progress. A positive underwriting cycle and significantly
deeper discounts available to our major competitors, created an environment
in which Destiny is simply not price competitive - particularly in
Illinois, Destiny"s major market - resulting in slow growth and worse-than-
expected loss ratios.
In addition, Destiny"s pace of expansion into other markets wherein it
could compete was inadequate and contingent upon partner influences. Since
the half year, substantial steps have been taken to address the situation:
- The appointment of a new CEO
- A focus on appropriately increasing premium rates to address the elevated
loss ratio and return it to the correct level
- A mutual agreement with Tufts Health Plan to terminate our joint venture
to allow for correct focus on growth opportunities
- A significant leaning down of the operations to reflect the realities of
the business
- The recruitment of senior resources
- A focus on obtaining competitive network discounts
- The expansion into more promising markets, like Texas.
The resulting operating losses reflect the tail-end of the issues, and the
steps taken have had a significant impact. It is anticipated that the
emerging losses will be minimised and reduced rapidly.
However, Discovery has made the decision that the business model and
strategy is not sustainable and must change. Discovery, Destiny Health and
the Guardian Life Assurance Company of New York (Destiny Health"s exclusive
distribution partner in the US) are in the process of revisiting their
partnership arrangement. Potential changes may include a construct wherein
Destiny will provide the intellectual capital and an operational platform
for the Guardian in return for a fixed fee per member in some states in the
US, while Destiny Health will market its own products in other US states.
However, it must be stressed that any growth outside of this will be
opportunistic, confined to those markets where competitive pricing can be
obtained and will be pursued with great care to limit any downside.
Vitality and the DiscoveryCard
Vitality performed well over the period. Operating profit increased by 11%
to R41 million (2005: R37 million), Vitality membership increased by 7% to
522 516 members (2005: 486 416 members), and the number of primary
DiscoveryCard-holders increased by 120% to 307 688 (2005: 139 563).
Vitality"s function is foundational across Discovery, and focus continues
to be applied to ensuring that its structure achieves the correct levels of
engagement and behavioural change. Its performance in this regard and in
creating a competitive advantage for all of Discovery"s businesses has been
remarkable. To ensure continual improvement, many of the benefit structures
were reworked during the year, most notably the introduction of kulula.com
as an air travel partner in addition to British Airways. This strengthens
the incentives for members to engage in healthy behaviours, thereby
boosting their Vitality statuses. The number of Vitality flights booked on
kulula.com per day exceeds 1 000 - which is greater than the historic total
monthly usage of the British Airways flight benefit. Over 200 000 Vitality
members are now actively training at the gyms in the Vitality network.
The growth of the DiscoveryCard has been pleasing. Its central purpose is
to offer a platform for both Discovery Health and Discovery Life to enhance
their value propositions for their clients. This has been a particularly
successful strategy and the launch of the Discovery Life Card Integrator
during the year is a clear and powerful illustration of this. In addition
to this, in and of itself, the DiscoveryCard represents a powerful entry
into the credit card marketplace and the growth of the advances portfolio
to in excess of R1,1 billion is testimony to its success. Discovery remains
confident and optimistic that its value proposition places it in a uniquely
competitive position. Discovery expects continued evolution and growth from
and through the DiscoveryCard.
PruHealth
The performance of PruHealth, Discovery"s 50% joint venture with the
Prudential plc, was particularly pleasing. Members covered increased 696%
to 58 912 (2005: 7 400), while new business increased by 705% to R282
million (2005: R35 million).
During the year under review, the company has made a significant impact on
the UK private medical insurance (PMI) market. It has taken a leadership
position intellectually and in terms of product construct, and its
operational execution has been robust and thorough. The central Vitality
philosophy of incentivising better health has been exceptionally well
received in the marketplace and is wholly consistent with government policy
and practice. The impressive levels of new business production over the
year reflect a successful strategy in every respect.
PruHealth distributes its products through both broker (IFA) and direct-to-
consumer (D2C) distribution channels. The IFA channel has been remarkably
receptive from the outset and over the year exceeded our target, with
continued growth in both depth and breadth. A pleasing development during
the year has been the increasing success of the D2C channel and, in
particular, the online channel. Importantly, the D2C channel attracts
individual business, which is significantly more profitable. This bodes
well for future growth and profitability.
From an actuarial perspective, a central strategy designed to ensure price
competitiveness is the use of the Vitality structure to induce greater
persistency, thereby leading to superior durational morbidity experience.
Early indications are positive, with 100% of small and medium size
companies (SME"s) renewing their coverage.
Going forward, PruHealth is well positioned for continued growth. It is
pursuing a number of key strategies, including the broadening of its
distribution channels to the generalist IFA"s and an acceleration of its
D2C execution.
LL Dippenaar A Gore
Chairman Chief Executive Officer
5 September 2006
Directors
LL Dippenaar (Chairman), A Gore (Chief Executive Officer), JM Robertson*,
Dr BA Brink, JP Burger, Dr NJ Dlamini, SB Epstein (USA), MI Hilkowitz
(Israel), NS Koopowitz*, Dr TV Maphai**, HP Mayers*, S Sebotsa**, B
Swartzberg*, SV Zilwa, SD Whyte*
*Executive **Appointed 8 December 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)
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
Income statement
for the year ended 30 June 2006
Group Group %
R million 2006 2005 Change
Insurance premium revenue 2 824 1 838
Reinsurance premiums (456) (378)
Net insurance premiums 2 368 1 460
Fee income 1 961 1 670
Investment income 161 106
Net realised gains 157 53
Net fair value gains on financial
assets at fair
value through profit and loss 121 122
Vitality income 654 521
Net income 5 422 3 932
Insurance benefits and claims (1 348) (828)
Insurance claims recovered from 374 251
reinsurers
Net insurance benefits and claims (974) (577)
Acquisition costs (908) (714)
Marketing and administration expenses (2 624) (2 168)
Transfer from assets/liabilities 468 572
under insurance contracts
Fair value adjustment to liabilities
under
investment contracts (121) (122)
Profit before BEE expenses 1 263 923 37
BEE expenses (161) -
Profit from operations 1 102 923
Finance costs (21) (64)
Foreign exchange loss - unrealised (7) (8)
Share of profit from associate 2 2
Profit before taxation 1 076 853 26
Taxation (410) (305)
Profit for the year 666 548 22
Attributable to:
Equity holders 669 557
Minority interests (3) (9)
666 548
Earnings per share for profit
attributable to
the equity holders during the year
(cents):
-basic 126.5 107.3 18
-diluted 121.0 103.0 17
Weighted number of shares in issue 528 946 519 188
(000"s)
Diluted weighted number of shares 574 871 553 227
(000"s)
Balance sheet
at 30 June 2006
Group Group
R million 2006 2005
ASSETS
Property and equipment 186 219
Intangible assets including deferred acquisition 66 46
costs
Assets arising from insurance contracts 2 463 1 881
Investment in associate 7 4
Financial assets
- Equity investments 1 600 1 259
- Equity linked notes 77 -
- Government and public authority stocks 233 186
- Money market 206 159
- Loans and receivables including insurance 559 556
receivables
Deferred income tax 41 35
Reinsurance assets 32 19
Cash and cash equivalents 1 322 916
Total assets 6 792 5 280
EQUITY
Capital and reserves
Share capital and share premium 1 348 1 336
Other reserves 640 330
Retained earnings 2 224 1 557
4 212 3 223
Minority interest - 67
Total equity 4 212 3 290
LIABILITIES
Liabilities arising from insurance contracts 464 309
Liabilities arising from reinsurance contracts 24 31
Financial liabilities
-Investment contracts at fair value through 604 483
profit and loss
-Borrowings at amortised cost 161 136
Deferred income tax 518 323
Deferred revenue 203 254
Provisions 36 30
Trade and other payables 522 407
Current income tax liabilities 48 17
Total liabilities 2 580 1 990
Total equity and liabilities 6 792 5 280
Cash flow statement
for the year ended 30 June 2006
Group Group
R million 2006 2005
Cash flow from operating activities 580 408
Cash generated by operations 439 575
Working capital changes 217 10
656 585
Dividends received 33 23
Interest received 122 72
Financing costs (22) (93)
Taxation paid (209) (179)
Cash flow from investing activities (138) (210)
Net purchases of investments (46) (77)
Purchase of property and equipment (59) (106)
Proceeds on disposal of property and equipment 1 -
Purchase of intangible assets (34) (30)
Decrease in loans receivable - 3
Cash flow from financing activities (39) (134)
Proceeds from shares issued 23 71
Share issue costs written off against share (4) (1)
capital
Dividends paid to Destiny Health preference (1) (1)
shareholders
Minority share buy-back (6) (1)
Increase/(repayment) of borrowings 16 (202)
Redemption of Destiny preference shareholders (67) -
Net increase in cash and cash equivalents 403 64
Cash and cash equivalents at beginning of year 916 845
Exchange gains on cash and cash equivalents 3 7
Cash and cash equivalents at end of year 1 322 916
statement of changes in equity
for the year ended 30 June 2006
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 2005
Balance at 1 July 2004 1 276 - 51 69
Issue of capital 61 - - -
Share issue expenses (1) - - -
Movement in share-
based payment reserve - 20 - -
Unrealised gains on - - 240 -
investments
Capital gains tax on
unrealised
gains on investments - - (34) -
Realised gains on
investments
transferred to income - - (53) -
statement
Capital gains tax on
realised
gains on investments - - 5 -
Translation of foreign - - - 29
subsidiary
Transfer to hedging - - - -
reserve
Net profit for the - - - -
period
Dividends paid to
Destiny
Health preference - - - -
shareholders
Realised loss on
minority
share buy-back - - - -
Balance at 30 June 1 336 20 209 98
2005
30 June 2006
Balance at 1 July 2005 1 336 20 209 98
Issue of capital 16 - - -
Share issue expenses (4) - - -
Movement in share-
based payment reserve - 185 - -
Unrealised gains on - - 288 -
investments
Capital gains tax on
unrealised
gains on investments - - (39) -
Realised gains on
investments
transferred to income - - (157) -
statement
Capital gains tax on
realised
gains on investments - - 18 -
Translation of foreign - - - 14
subsidiary
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
Hedging Retained Minority
R million reserve earnings interest Total
30 June 2005
Balance at 1 July 2004 (6) 1 002 67 2 459
Issue of capital - - 9 70
Share issue expenses - - - (1)
Movement in share-
based payment reserve - - - 20
Unrealised gains on - - - 240
investments
Capital gains tax on
unrealised
gains on investments - - - (34)
Realised gains on
investments
transferred to income - - - (53)
statement
Capital gains tax on
realised
gains on investments - - - 5
Translation of foreign - - - 29
subsidiary
Transfer to hedging 9 - - 9
reserve
Net profit for the - 557 (9) 548
period
Dividends paid to
Destiny
Health preference - (1) - (1)
shareholders
Realised loss on
minority
share buy-back - (1) - (1)
Balance at 30 June 2005 3 1 557 67 3 290
30 June 2006
Balance at 1 July 2005 3 1 557 67 3 290
Issue of capital - - 3 19
Share issue expenses - - - (4)
Movement in share-
based payment reserve - - - 185
Unrealised gains on - - - 288
investments
Capital gains tax on
unrealised
gains on investments - - - (39)
Realised gains on
investments
transferred to income - - - (157)
statement
Capital gains tax on
realised
gains on investments - - - 18
Translation of foreign - - - 14
subsidiary
Transfer to hedging 1 - - 1
reserve
Net profit for the - 669 (3) 666
period
Dividends paid to
Destiny Health
preference shareholders - (1) - (1)
Realised loss on
minority
share buy-back - (1) - (1)
Redemption of Destiny
Health
preference shares - - (67) (67)
Balance at 30 June 2006 4 2 224 - 4 212
Segmental information
for the year ended 30 June 2006
Health
United
South States United
of
R million Africa America Kingdom Life Vitality Total
30 June 2006
New business 2 505 796 282 789 107 4 479
annualised
premium income*
Gross inflows 16 542 1 322 141 1 768 654 20 427
under
management*
Income statement
Insurance 74 911 71 1 768 - 2 824
premium revenue
Reinsurance (2) (81) - (373) - (456)
premiums
Fee income 1 961 - - - - 1 961
Investment 34 9 4 382 10 439
income and gains
Vitality income - - - - 654 654
Net income 2 067 839 75 1 777 664 5 422
Insurance (57) (656) (43) (592) - (1 348)
benefits and
claims
Insurance claims 2 76 - 296 - 374
recovered from
reinsurers
Acquisitions - (82) (8) (752) (66) (908)
costs
Marketing and (1 319) (242) (153) (363) (547) (2 624)
administration
expenses
Transfer from
assets/liabiliti
es under
insurance (4) (77) (13) 562 - 468
contracts
Fair value
adjustment to
liabilities
under
investment - - - (121) - (121)
contracts
Expenses (1 378) (981) (217) (970) (613) (4 159)
Profit from 689 (142) (142) 807 51 1 263
operations
BEE expenses (161)
Finance costs (21)
Foreign exchange (7)
loss -
unrealised
Share of profit 2
from associate
Profit before 1 076
taxation
Taxation (410)
Profit for the 666
year
30 June 2005
New business 2 776 809 35 629 93 4 342
annualised
premium income*
Gross inflows 14 571 914 11 1 278 521 17 295
under
management*
Income statement
Insurance 18 537 5 1 278 - 1 838
premium revenue
Reinsurance (3) (53) - (322) - (378)
premiums
Fee income 1 670 - - - - 1 670
Investment 26 4 6 237 8 281
income and gains
Vitality income - - - - 521 521
Net income 1 711 488 11 1 193 529 3 932
Insurance (3) (392) (3) (430) - (828)
benefits and
claims
Insurance claims - 43 - 208 - 251
recovered from
reinsurers
Acquisitions - (42) - (617) (55) (714)
costs
General
marketing and
administration
expenses (1 134) (183) (150) (272) (429) (2 168)
Transfer from
assets/liabiliti
es under
insurance - - - 572 - 572
contracts
Fair value
adjustment to
liabilities
under
investment - - - (122) - (122)
contracts
Expenses (1 137) (574) (153) (661) (484) (3 009)
Profit from 574 (86) (142) 532 45 923
operations
Finance costs (64)
Foreign exchange (8)
loss -
unrealised
Share of profit 2
from associate
Profit before 853
taxation
Taxation (305)
Profit for the 548
year
* New business annualised premium income and gross inflows under management
includes 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 2006
The embedded value of Discovery at 30 June 2006 is calculated as the sum of
the following components:
- the excess assets over liabilities at the valuation date (i.e. net asset
value); 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.
In the past, Life has based the embedded value on the Financial Soundness
Valuation Method (FSV). A change in actuarial guidance note (PGN107)
effective for financial year-ends on or after 31 December 2005 now requires
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
capatalised 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 in-force and the value of new business at 30 June 2006 are
shown on both the SVM and the FSV bases to allow comparison to prior
periods. 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 and STC.For PruHealth, no value has been placed on the
current in-force business. PricewaterhouseCoopers Assurance Services (Pty)
Ltd has reviewed the calculation of the value of in-force business, the
value of new business, including the methodology and assumptions underlying
these calculations. They have reported that the accompanying embedded value
and disclosure complies in all material respects with the actuarial
principles as set out in Professional Guidance Note 107 of the Actuarial
Society of South Africa. A letter from PricewaterhouseCoopers Assurance
Services (Pty) Ltd, summarising the results of their review, is included in
the annual report.
Table 1: Group embedded value
at 30 June
2006 2006 2005 %
R million SVM Basis FSV basis change
Shareholders" funds 4 212 4 212 3 290(1) 28
Minority interest - - (67)
Elimination of assets (2 088) - -
under insurance
contracts
Shareholders" funds
excluding assets under
insurance contracts and 2 124 4 212 3 223
minority interest
Value of in-force 8 774 7 141 6 483
business before cost of
capital
Cost of capital (60) (492) (533)
Cost of STC(2) (251) (222) -
Discovery Holdings 10 587 10 639 9 173 15
embedded value
Number of shares 533,4 533,4 528,2
(millions)
Embedded value per share R19,85 R19,95 R17,37 14
Diluted number of shares 553,2 553,2 553,2
(millions)
Diluted embedded value R19,47 R19,57 R16,93 15
per share(3)
(1) The shareholders" funds balance has been adjusted following the
adoption of IFRS.
(2) In line with Discovery"s current dividend policy, the cost of
secondary tax on companies (STC) is calculated assuming a 4,5 times
dividend cover on the after-tax profits as they emerge over the projection
term. The after-tax profits will differ depending on whether the SVM or FSV
basis is used. The total STC charge has been allocated between the
different business entities based on their contribution to the total value
of in-force. Previously, Discovery"s policy was not to declare dividends
and therefore no allowance was made in the embedded value calculation for
STC. The cost of STC at 30 June 2005 would have been R171 million on the
same basis.
(3) 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. No allowance has been made for Discovery"s BEE transaction as
the impact would be anti-dilutive due to the transaction price exceeding
the current embedded value per share.
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 2006 -
SVM Basis
Health and Vitality 4 258 - (122) 4 136
Life(1) 4 496 (45) (129) 4 322
Destiny Health(2) 20 (15) (0) 5
Total 8 774 (60) (251) 8 463
at 30 June 2006 -
FSV Basis
Health and Vitality 4 258 - (133) 4 125
Life(1) 2 863 (477) (89) 2 297
Destiny Health(2) 20 (15) (0) 5
Total 7 141 (492) (222) 6 427
at 30 June 2005
Health and Vitality 3 844 - - 3 844
Life(1) 2 349 (517) - 1 832
Destiny Health 290 (16) - 274
Total 6 483 (533) - 5 950
(1) On the SVM basis, the Life cost of capital is based on a capital
adequacy requirement at June 2006 of R94 million. On the FSV basis, the
Life cost of capital is based on a capital adequacy requirement at June
2006 of R2 240 million (June 2005: R1 507 million on the FSV basis).
(2) The reduction in the value of Destiny Health follows a review of the
long term assumptions for the existing business taking account of the poor
performance experienced over the past year and changes to the alliance with
Tufts Health Plan. The values for Destiny Health reflect Discovery"s 98.05%
shareholding in Destiny Health at 30 June 2006.
Table 3: Group embedded value earnings
for the year ended 30 June
R million 2006 2005
Embedded value at end of period 10 587 9 173
Less: Embedded value at beginning of (9 173) (6 832)
period
Increase in embedded value 1 414 2 341
Net issue of capital (12) (60)
Dividends paid to Destiny preference 1 1
shareholders
Realised loss on minority share buy-back 1 -
Transfer to hedging reserve (1) (9)
Embedded value earnings 1 403 2 273
Return on embedded value 15.3% 33.3%
Table 4: Components of Group embedded value earnings
for the year ended 30 June
%
R million 2006 2005 change
Total profit from new business (at 572 783 (27)
point of sale)
Profit from existing business
Expected return(1) 756 602
Change in methodology and (540) 307
assumptions(2)
Experience variances(3) 262 363
PruHealth start-up costs (128) (120)
Adjustment for minority interest 10 4
in Destiny Health
Adjustment for Guardian profit 1 (28)
share in Destiny Health(4)
Foreign exchange rate movements (4) 43
Interest on loan capital - (50)
IFRS Adjustment - (8)
Return on shareholders" funds(5) 474 377
Embedded value earnings 1 403 2 273
(1) The expected return is based on the FSV method.
(2) 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
are based on the FSV method. The modelling change, moving from the FSV
method to the SVM, is included as the last step in the change in
methodology and assumptions.
(3) The experience variances are shown on the FSV methodology.
(4) In terms of the agreement between Destiny Health and the Guardian Life
Insurance Company of America, Guardian shares in 50% of the profits from
business written by Destiny Health prior to the agreement with Guardian
(i.e. non-alliance business) once the business written by Guardian reaches
the contractual new member threshold. This threshold has now been reached.
(5) Return on shareholders" funds is shown net of tax and management
charges and includes the return on assets under insurance contracts, under
the FSV method.
Table 5: Methodology and assumption changes
for the year ended 30 June 2006
Health and Destiny Life
Vitality Health
Net Value Net Value Net Value
of of of
R million worth in- worth in- worth in- Total
force force force
Lapses - 68 - (32) (62) (94) (120)
Economic - (45) - - (18) (90) (153)
assumptions
Premium - - - 23 101 8 132
Increases
Administration - (443) - - - - (443)
Fees(1)
Benefit - - - - (33) (30) (63)
Enhancements(2)
Expenses(3) - 462 - (78) 4 7 395
Cash Settled - (67) - - - (11) (78)
Share Based
Payments(4)
Vitality - 79 - - - - 79
benefits(5)
Mortality and - - - (160) - - (160)
Morbidity
Tax(6) - - - - - (20) (20)
Cost of STC(7) - (119) - - - (114) (233)
Modelling - - - 20 (1 1 634 127
changes(8) 527)
Other - - - (3) 0 0 (3)
Total - (65) - (230) (1 1 290 (540)
535)
(1) The Health administration fee change relates to a reduction in
Discovery Health Medical Scheme administration fees from 1 July 2006.
(2) The Life benefit enhancements relate primarily to enhancements on the
Integrator product.
(3) The Health and Vitality renewal expense assumption change is based on
the results of the most recent expense analysis and allows for the expense
efficiencies achieved by management over the past six months.
(4) This assumption reflects the capitalised cost of cash-settled share-
based payments made over the past year, and assumes a similar cost in each
future year for the full projection term.
(5) The Health and Vitality assumption change includes an allowance for a
reduction in the expected benefit cost on Vitality in line with recent
experience.
(6) The tax variance reflects the movement in the value of the tax
deferral related to the deferred tax liability under the FSV method.
(7) Following the change to Discovery"s dividend policy, the cost of STC
is now modelled assuming a 4,5 times dividend cover.
(8) The Life modelling change includes a R1 536 million decrease in the
net worth and a R1 470 million increase in the value of in-force in respect
of the change from the Financial Soundness Valuation basis to the Statutory
Valuation Method used to calculate the embedded value. The R1 470 million
increase in the value of in-force includes a reduction of R311 million in
the Cost of Capital.
The value of in-force includes a further reduction of R200 million in the
cost of capital due to changes in the future projection of the Statutory
CAR.
Table 6: Experience variances
for the year ended 30 June 2006
Health and Destiny Life
Vitality Health
Net Value of Net Value Net Value
of of
R million worth in-force worth in- worth in- Total
force force
Renewal 37 - (49) - 6 - (6)
expenses
Other - - (2) - (25) - (27)
expenses(1)
Inflation(2) (6) (67) - - 32 18 (23)
Extended - 212 - 23 - 6 241
modelling
term(3)
Lapses(4) 21 177 (0) (118) (40) (16) 24
Policy - 6 - - 24 29 59
alterations(5)
Mortality and - - (122) - 60 21 (41)
morbidity
Deferred - - - - 31 (31) -
profits
released
Commission(6) - - - - (12) - (12)
Vitality 25 - - - - - 25
premium and
benefits
Other 13 1 2 16 (8) (2) 22
Total 90 329 (171) (79) 68 25 262
(1) For Life, the non-recurring expenses relate to costs incurred as a
result of the venture with Prudential in the UK.
(2) The negative variance for Health and Vitality is due to a lower
increase in the Health administration fees in 2006 compared with that
assumed in June 2005.
The Life variance is primarily due to automatic premium increases being
higher than expected.
(3) The projection term for Health, Vitality, Destiny Health and Group
Life at 30 June 2006 has not been changed from that used at 30 June 2005.
Thus, an experience variance arises because the total term of the in-force
business is effectively increased by twelve months.
(4) Included in the Health and Vitality lapse experience variance is an
amount of R392 million in respect of members joining existing employer
groups during the period, offset by an amount of R244 million in respect of
members leaving existing employer groups. A positive variance of R59
million is due to lower than expected lapses.
(5) The Life policy alterations relate to benefit alterations to risk
benefits. The impact of existing policies adding the Discovery Retirement
Optimiser is included in the value of new business.
(6) The commission variance includes a provision for bad debts on
commission clawbacks and includes commissions paid in respect of business
incepting after the valuation date.
Table 7: Embedded value of new business
for the year ended 30 June
2006 2006 2005 %
R million SVM Basis FSV basis change
Health and Vitality
Gross profit from new 115 115 229
business at point of sale
Cost of capital - - -
Cost of STC (3) (3) -
Net profit from new 112 112 229 (51)
business at point of sale
New business annualised 1 121 1 121 1 734 (35)
premium income(1)
Life
Gross profit from new 532 679 676
business at point of sale
Cost of capital (7) (129) (157)
Cost of STC (15) (21) -
Net profit from new 510 529 519 (2)
business at point of sale
New business annualised 592 592 470 26
premium income(2)
Annualised profit margin(3) 10,8% 11,3% 13,5%
Destiny Health
Gross profit from new (50) (50) 36
business at point of sale
Cost of capital(4) (0) (0) (1)
Cost of STC 0 0 -
Net profit from new (50) (50) 35
business at point of
sale(5)
New business annualised 457 457 603 (24)
premium income(1)
New business annualised
premium income
(US$ million) 71 71 97 (27)
(1) Health and Destiny Health new business annualised premium income is
the gross contribution. For embedded value purposes, Health and Destiny
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 2006.
The total Health and Vitality new business annualised premium income
written over the period was R2 612 million (June 2005: R2 869 million). The
value of Health and Vitality new business has been calculated using a
renewal expense assumption based on an average cost per policy rather than
a marginal cost per policy. The average cost assumption, combined with an
increase in sales of lower margin business, has resulted in a reduction in
the new business margin. For Destiny Health, the total new business
annualised premium income written over the period was R796 million (June
2005: R809 million).
(2) 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 R592 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 R103
million and servicing increases of R94 million was R789 million. Single
premium business is included at 10% of the value of the single premium. R24
million of single premium business was written over the period.
Discovery Retirement Optimisers added to existing Life Plans have been
included in the value of new business.
(3) The annualised profit margin is the value of new business expressed as
a percentage of the present value of future premiums.
(4) 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 deducted from gross
profit in the new business calculation.
(5) The Destiny Health value of new business allows for the actual new
business expenses incurred over the past year. Actual new business expenses
include infrastructure development costs related to developing new business
capacity. This value includes acquisition costs in respect of Tufts new
business written over the past year which is expected to run-off over the
next 18 months.
Table 8: Embedded value assumptions
at 30 June
2006 2005
Risk discount
rate (%)
- Health and 12,00 11,00
Vitality
- Life 12,00 11,00
- Destiny Health 10,00 10,00
Medical inflation
(%)
South Africa 8,00 7,00
United States Current levels Current levels
reducing reducing
to 13,00% over to 12,50% over
the projection the projection
period period
Expense inflation
(%)
South Africa 5,00 4,00
United States 3,00 3,00
Pre-tax
investment return
(%)
South Africa - Cash 7,50 6,50
- Bonds 9,00 8,00
- Equity 11,00 10,00
United States - Bonds 3,00 3,00
Dividend cover 4,5 times -
ratio
Income tax rate
(%)
- South Africa 29,00 29,00
- United States 34,00 34,00
Federal 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. 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 management"s
expectations of the likely impact of future premium increases on
experience. Renewal expense assumptions were based on the results of the
latest expense investigation.
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 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. 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 2006 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
Base 2 124 4 258 - (122)
Impact of:
Risk 2 124 4 107 - (116)
discount
rate +1%
Risk 2 124 4 419 - (129)
discount
rate -1%
Lapses +10% 2 124 4 175 - (120)
Investment 2 124 4 258 - (121)
return
-1%(1)
Renewal 2 124 3 755 - (108)
expenses
+10%
Mortality 2 124 4 258 - (122)
and
Morbidity
+10%
Health,
Vitality and
Destiny
Health:
Projection 2 124 4 469 - (128)
term +1 year
Destiny Health Life
Value Cost of Cost of Value Cost of Cost of
STC in-force capital STC in-force capital
Base 20 (15) (0) 4 496 (45) (129)
Impact of:
Risk 18 (16) (0) 4 201 (52) (119)
discount
rate +1%
Risk 23 (13) (1) 4 841 (35) (142)
discount
rate -1%
Lapses 17 (14) (0) 4 258 (40) (122)
+10%
Investment 17 (17) (0) 4 310 (55) (123)
return
-1%(1)
Renewal (50) (15) 1 4 452 (45) (128)
expenses
+10%
Mortality (234) (15) 6 3 934 (45) (113)
and
Morbidity
+10%
Health,
Vitality
and
Destiny
Health:
Projection 31 (16) (1) 4 496 (45) (129)
term +1
year
Embedded %
STC value change
Base 10 587
Impact of:
Risk discount rate 10 147 (4)
+1%
Risk discount rate 11 087 5
-1%
Lapses +10% 10 278 (3)
Investment return 10 393 (2)
-1%(1)
Renewal expenses 9 986 (6)
+10%
Mortality and 9 793 (7)
Morbidity +10%
Health, Vitality
and
Destiny Health:
Projection term +1 10 801 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 Destiny Health
Value Cost of Cost of Value Cost of Cost
of
R million in- capital STC in- capital STC
force force
Base 115 - (3) (50) (0) 0
Impact of:
Risk 104 - (3) (51) (0) 1
discount
rate +1%
Risk 126 - (4) (49) (0) 1
discount
rate -1%
Lapses + 108 - (3) (51) (0) 1
10%
Investment 115 - (3) (50) (0) 1
Return
-1%(1)
Renewal 75 - (2) (71) (0) 2
expenses
+10%
Mortality 115 - (3) (105) (0) 3
and
Morbidity
+10%
Health,
Vitality
and
Destiny 128 - (4) (48) (0) 1
Health:
Projection
Term +1
year
Acquisition 95 - (3) (59) (0) 0
expenses
+10%
Life Value
Value Cost of Cost of new %
of
R million in- capital STC business change
force
Base 532 (7) (15) 572
Impact of:
Risk 452 (8) (14) 481 (16)
discount
rate +1%
Risk 627 (6) (16) 679 19
discount
rate -1%
Lapses + 469 (6) (14) 504 (12)
10%
Investment 480 (9) (14) 520 (9)
Return
-1%(1)
Renewal 520 (7) (15) 502 (12)
expenses
+10%
Mortality 399 (7) (13) 389 (32)
and
Morbidity
+10%
Health,
Vitality
and
Destiny 532 (7) (15) 587 3
Health:
Projection
Term +1
year
Acquisition 497 (7) (15) 508 (11)
expenses
+10%
(1) For Life, both investment return and inflation assumptions were reduced
by 1%.
Review of Group results
Gross inflows under management, increased 18% for the year ended 30 June
2006. 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 2006 2005 change
Discovery Health 16 542 14 571 14
Discovery Life 1 768 1 278 38
Discovery Vitality 654 521 26
Destiny Health 1 322 914 45
PruHealth 141 11
Gross inflows under management 20 427 17 295 18
Less: collected on behalf of third (14 988) (13 266)
parties
Discovery Health (14 507) (12 883)
Destiny Health (411) (377)
PruHealth (70) (6)
Gross income of Group 5 439 4 029 35
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 2006 2005 change
Discovery Health 655 548 20
Discovery Life 546 417 31
Discovery Vitality 41 37 11
Destiny Health (151) (90) (68)
PruHealth (146) (148) 1
Group operating profit before investment 945 764 24
income
Investment income 161 106
Realised and unrealised gains and losses 278 175
Fair value adjustment to liabilities under (121) (122)
investment contracts
Profit from operations before BEE expense 1 263 923 37
Headline earnings
Headline earnings in compliance with International Financial Reporting
Standards (IFRS) increased by 36% excluding the impact of the BEE
transaction. Unrealised gains of R288 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 2006 2005 change
Net profit attributable to equity 669 557 20
shareholders
Adjusted for:
- realised profit on available-for-sale (139) (48)
investments net of CGT
- impairment of property and equipment 1 -
Headline earnings 531 509 4
BEE expenses 161 -
Headline earnings before BEE transaction 692 509 36
Headline earnings per share before BEE
transaction (cents)*
- undiluted 130,8 98,0 33
- diluted 126,4 94,2 34
Headline earnings per share (cents)
- undiluted 100,4 98,0 2
- diluted 97,0 94,2 3
*For this purpose, the impact of the BEE deal has been excluded from both
earnings and the number of shares in issue.
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 accounted for 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.
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 R582 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. During the year, Destiny redeemed US$9 million of
Series A preference shares leading to a reduction in outside shareholders
of R67 million. BEE transaction
In December 2005, Discovery issued 38,7 million shares in terms of its BEE
transaction. The special purpose vehicles and trusts to which these shares
have been issued, have been consolidated into the accounts of Discovery,
eliminating the share issue.
These shares have been included in the calculation of diluted HEPS and
diluted EPS.
The International Financial Reporting Interpretations Committee (IFRIC)
released IFRIC 8 "Scope of IFRS 2" confirming that BEE transactions should
be accounted for under IFRS 2.
Discovery has early adopted IFRIC 8, resulting in a charge to the income
statement of R161 million in the year ended 30 June 2006. This charge
represents the financial effects of the BEE transaction.
An additional R24 million in respect of equity settled share based payments
and R6 million in respect of cash settled share based payments, granted
under employee share incentive schemes, has been expensed in the income
statement 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.
These are Discovery"s first IFRS annual financial statements and the
provisions of IFRS 1 First-time adoption of International Financial
Reporting Standards, have been applied.
Shareholders are referred to the IFRS announcement published 24 February
2006, regarding details of the financial restatement impact as a
consequence of the IFRS adoption. All comparatives have been restated as
publlished in that announcement.
Directorate
Dr T V Maphai and Mrs S Sebotsa were appointed as non-executive directors
to the board of Discovery, with effect from 8 December 2005.
Dividend policy and capital
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 R94 million (2005: R77 million) and
were covered 14.0 times (2005: 12.9 times).
Dividend declaration
The board has declared a maiden dividend of 27 cents per share. The salient
dates are as follows:
Last date to trade "cum" dividend Friday, 13 October 2006
Date trading commences "ex" dividend Monday, 16 October 2006
Record date Friday, 20 October 2006
Date of payment Monday, 23 October 2006
Share certificates may not be dematerialised or rematerialised between
Monday, 16 October 2006 and Friday, 20 October 2006, both days inclusive.
Audit
The auditors, PricewaterhouseCoopers Inc., have issued their opinion on the
Group financial statements for the year ended 30 June 2006. A copy of the
auditors" unqualified report is available for inspection at the company"s
registered office.
www.discovery.co.za
Date: 06/09/2006 08:31:12 AM Produced by the JSE SENS Department
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