| Thu 22 Feb 2007, 9:08 | | DSY - Discovery - Unaudited interim results: six m |
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DSY
DSY
DSY - Discovery - Unaudited interim results: six months ended 31 December 2006
Discovery Holdings Limited
(Incorporated in the Republic of South Africa)
(Registration number: 1999/007789/06)
JSE share code: DSY
ISIN: ZAE000022331
Unaudited interim results for the six months ended 31 December 2006
Operating profit before investment income +40% to R530 million
Diluted HEPS before BEE +29% to 70,1 cents per share
Destiny operating losses reduced by 59% to R33 million
Pruhealth achieves 100 000 members in January
New business +19% to R2,5 billion
Discovery Health members under administration exceed 2 million in January
Introduction
The period under review has been a particularly successful one for Discovery in
respect of two fundamental issues. Firstly, the financial performance has been
pleasing, reflecting the consistent and strong performance of Discovery`s
underlying businesses. Secondly, significant and fundamental foundations were
built for future growth initiatives.
Discovery`s core purpose of "making people healthier and enhancing and
protecting their lives" has become more relevant with time and falls squarely in
line with the important global trends of consumerism and wellness. Discovery`s
view is that its ability to structure its businesses on the foundation of
engaging its clients and enhancing their lives through health, places it in a
unique position to add value to its clients and remain sustainably competitive.
For the period under review, group operating profit increased by 40% before
investment income, tax and the impact of its BEE transaction to R530 million
(2005: R379 million). Diluted headline earnings per share before the impact of
the BEE transaction rose 29% to 70.1 cents (2005: 54.3 cents). New business grew
to a record-breaking level of R2.5 billion.
Discovery Health
Discovery Health`s performance over the period was robust and pleasing.
Through growth, efficiency and a focus on operational and service excellence, a
substantial increase in operating profit was achieved.
Operating profit before investment income rose by 29% to R342 million (2005:R265
million), with new business improving to R1 233 million (2005: R1 211 million).
Improved efficiencies allowed staff headcount to reduce by 5% to 2 902 (2005: 3
055), despite a 7% increase in the number of covered lives, which rose to 1 981
867 (2005: 1 844 697). Lapse rates also improved down from 2.6% to 2.1%.
Given the size of Discovery Health and that of the Discovery Health Medical
Scheme, it is fundamental that Discovery Health transforms its value proposition
from being just a funder in the health care system towards reaching into the
system and creating structures that ensure members get access to a health care
system of exceptional quality, ease of use and one that costs less. During the
period under review, the formation of the Discovery GP Network was a key element
of this strategy. The objective of this strategy is to work constructively with
all health care professionals in order to build a robust and effective health
care system for members of Discovery Health. From a product and strategy
perspective, the results will be a significant competitive advantage, resulting
in further growth.
Discovery Life
Discovery Life continued to perform well over the period. The company grew
operating profit by 29% and annualised new business premium income rose 22% to
R480 million (2005: R392 million). The value of in-force business has also
increased strongly, growing by 22% to R5 068 million (2005: R4 151 million).
Gross inflows improved from R820 million in the previous period to R1 107
million an increase of 35%. The company`s strategy of maintaining and enhancing
its leadership position in the pure life assurance market (protection market)
was well demonstrated over the period. Its approach of innovation and
differentiation in its products, so that they add value to clients in what is
otherwise a commodity market, was illustrated by the roll-out of products such
as the DiscoveryCard Integrator. The DiscoveryCard Integrator provides unique
value to clients whilst ensuring competitive price points and superior
profitability to shareholders. It also demonstrates the effectiveness of
Discovery Life`s strategy of integrating life insurance with consumer-engagement
and wellness. Integrated policies have a higher average premium, higher average
number of ancillary benefits, lower loss ratios and better persistency levels
than corresponding non-integrated policies. During the period under review, the
DiscoveryCard Integrator amounted to 30% of new business produced by Discovery
Life. The product`s excellent progress to date bodes well for the future.
In June 2005, Discovery Life launched the Discovery retirement Optimiser as a
first niche step into the investment market. During the period under review,
considerable product and infrastructure development was undertaken in
preparation for a substantial launch into the mainstream long-term investment
market. Discovery Life is confident and optimistic of its potential in this
market.
In the UK, Discovery Life continues to work with the Prudential in testing its
products in the UK protection market. The current progress of these products
creates a future platform for Discovery Life to further penetrate this
significant and promising market.
PruHealth
PruHealth`s growth exceeded expectation and underscores Discovery`s confidence
in its ability to make an impact in the UK private medical insurance market. In
addition, the success of PruHealth reflects Discovery`s excellent working
relationship with the Prudential plc and the ability to coalesce the best of
both organisations for the benefit of clients.
PruHealth achieved strong new business growth in the period, up 260% from R77
million to R277 million. The number of lives covered grew by 277%, while
operating losses increased to GBP9 million (2005: GBP6 million).
The number of lives covered exceeded 89 000 by the end of the period under
review and had grown to 100 000 by the end of January 2007. The increase in
operating losses is consistent with the growth and associated acquisition costs
incurred in achieving it, as well as the significant investments made in the
initiatives to drive PruHealth going forward. As a consequence of this growth,
after the period under review, PruHealth entered into a reinsurance contract to
mitigate risk and provide relief for the large acquisition costs incurred.
The strategy going forward is not only to grow the business significantly, but
also to maximise the quality of the business transacted, and its resulting
profitability. PruHealth has embarked on clearly defined product and
distribution strategies for the key market segments: individual, corporate and
SME. For the individual market, PruHealth has been able to benefit from a multi-
distribution channel approach, encompassing both the direct-to-consumer and
individual broker markets. PruHealth(1)s direct consumer advertising and online
capabilities to transact new business have been particularly successful. In the
SME market, on the back of product enhancements announced in July, PruHealth is
in the process of expanding distribution with single line broker distribution
deals and plans to roll out a franchise-based distribution network. In the
corporate market, PruHealth has just introduced the new "Vitality Funding"
product. The model enables employers and employees to share the cost of health
care, with the employees` contributions reducing as they engage more in managing
their health. This approach reduces the immediate cost of the product for the
employer and provides strong incentives for employees to manage their health.
The early market feedback is positive.
Destiny Health
Destiny Health`s performance over the period was in line with expectations,
cutting operating losses by 59% reflecting the consequence of a successful
period of stabilisation. New business grew by 10% to $65 million US, while
membership reduced by 7% to 59 181 from 63 704 in the previous period, as a
result of lapses among poor-performing groups. The previous 18 months have been
a particularly difficult period for Destiny Health and Discovery made its
strategy clear that the business would be stabilised and turned around with
operating losses not exceeding 5% of the group`s overall operating profit.
During the period, a new management team focused successfully on bringing down
the elevated loss ratios, securing competitive network discounts, restructuring
the strategic partnership with the Guardian Life Insurance Company of America
and Tufts Health Plan and cutting operating costs within Destiny.
The initial results show promise, in that the business has not only reduced
operating losses, but it has also created robust foundations to grow to
profitability going forward. While Discovery is optimistic about the potential
for its business model in the US, it is also keenly aware of its limited success
in this market to date and therefore its view of Destiny`s future prospects
remains a cautious one.
Vitality
Vitality`s performance over the period exceeded expectation both financially and
in terms of its impact on Discovery`s clients and its other businesses.
Gross inflows increased by 13% to R355 million (2005: R315 million), with
operating profit up 63% to R26 million (2005: R16 million). The number of
primary DiscoveryCard-holders increased by 49% in the period to 353 541 (2005:
237 430).
Vitality is the manifestation of Discovery`s vision of making people healthy.
During the period under review, intensified focus was applied to the data and
experience of Vitality to ascertain precisely the triggers that are working to
make people healthier and how best to use this in Discovery`s other businesses.
It is believed that this strategy will ensure that Discovery`s health and life
insurance offerings are structurally more appropriate to its clients and more
competitive from a market perspective.
During the period, Vitality launched the WellPoint suite of products aimed at
making companies healthier and more productive. WellPoint is a substantial
product suite that brings together HIV management, employee assistance
programmes, preventive screening and absenteeism management. In each of these
categories, WellPoint integrates best-of-breed capabilities, so that they are
easy to implement and operate. In addition, the unique data-set that underlies
WellPoint coalesces together health data, absenteeism data and wellness data to
allow companies, together with Discovery, to manage the collective health of
their employee base. The market response to WellPoint has been particularly
positive and Discovery is optimistic about its prospects.
During the period, the performance of the DiscoveryCard was pleasing. The
fundamental philosophy behind the DiscoveryCard is to create structures and
services that differentiate Discovery`s life and health insurance offerings
examples of this strategy include the DiscoveryCard Integrator for Discovery
Life and the Health Plan Account for Discovery Health. Central to the strategy
is DiscoveryCard`s ability to offer added value as a credit card relative to
other traditional credit cards in the market-place. During the period, a
proliferation of bank and non-bank credit cards entered the market. Discovery is
particularly pleased that the first substantial independent survey comparing the
different value propositions rated the DiscoveryCard substantially ahead of its
competitors. This bodes well for DiscoveryCard`s ability to grow its membership
base, to grow in profitability and to enhance Discovery`s other offerings.
Prospects
All of Discovery`s businesses are well positioned for strong growth going
forward without requiring additional capital.
By order of the board
LL Dippenaar A Gore
Chairman Chief Executive Officer
21 February 2007
Directors
LL Dippenaar (Chairman), A Gore (Chief Executive Officer), Dr BA Brink, JP
Burger, Dr NJ Dlamini, SB Epstein (USA), PK Harris**, MI Hilkowitz (Israel), NS
Koopowitz*, Dr TV Maphai, HP Mayers*, JM Robertson*, S Sebotsa, B Swartzberg*,
SD Whyte*, SV Zilwa
*Executive **Appointed 15 February 2007
Transfer secretaries
Computershare Investor Services 2004 (Pty) Limited
(Registration number 2004/003647/07)
Ground Floor, 70 Marshall Street, Johannesburg, 2001
PO Box 61051, Marshalltown, 2107
Sponsors
Rand Merchant Bank (A division of FirstRand Bank Limited)
Secretary and registered office
MJ Botha
155 West Street, Sandton, 2146
PO Box 786722, Sandton, 2146
Tel: (011) 529 2888
Fax: (011) 529 2958
Income statement for the six months ended 31 December 2006
Group Group Group
Six Six Year
months months
ended ended ended
December December June
2006 2005 % 2006
R million Unaudited Unaudited change Audited
Insurance premium revenue 1 776 1 286 2 824
Reinsurance premiums (292) (229) (456)
Net insurance premiums 1 484 1 057 2 368
Fee income 1 007 922 1 961
Investment income 77 97 161
Net realised gains 40 50 157
Net fair value gains on
financial assets at fair
value through profit and 93 76 121
loss
Vitality income 355 315 654
Net income 3 056 2 517 5 422
Insurance benefits and (952) (681) (1 348)
claims
Insurance claims recovered 261 201 374
from reinsurers
Net insurance benefits and (691) (480) (974)
claims
Acquisition costs (509) (440) (908)
Marketing and administration (1 441) (1 288) (2 624)
expenses
Transfer from
assets/liabilities under
insurance contracts 325 293 468
Fair value adjustment to
liabilities under
investment contracts (95) (76) (121)
Profit before BEE expenses 645 526 23 1 263
BEE expenses (17) (144) (161)
Profit from operations 628 382 1 102
Finance costs (11) (10) (21)
Foreign exchange 1 - (7)
profit/(loss) - unrealised
Share of profit from 2 - 2
associates
Profit before taxation 620 372 67 1 076
Taxation (216) (178) (410)
Profit for the year 404 194 108 666
Attributable to:
Equity holders 403 194 669
Minority interests 1 - (3)
404 194 666
Earnings per share for
profit
attributable to the
equity holders (cents):
- basic 75,3 36,8 105 126,5
- diluted 72,1 35,9 101 121,0
Weighted number of shares in 535 202 528 468 528 946
issue (000`s)
Diluted weighted number of 591 953 553 749 574 871
shares (000`s)
Balance sheet at 31 December 2006
Group Group
December June
2006 2006
R million Unaudited Audited
ASSETS
Property and equipment 189 186
Intangible assets including deferred acquisition 74 66
costs
Assets arising from insurance contracts 2 812 2 463
Investment in associates 3 7
Financial assets
- Equity investments 1 945 1 600
- Government and public authority stocks 323 233
- Money market 494 206
- Equity-linked notes 87 77
- Loans and receivables including insurance 638 559
receivables
Deferred income tax 48 41
Reinsurance assets 37 32
Current income tax assets 18 -
Cash and cash equivalents 882 1 322
Total assets 7 550 6 792
EQUITY
Capital and reserves
Share capital and share premium 1 387 1 348
Other reserves 849 640
Retained earnings 2 471 2 224
Total equity 4 707 4 212
LIABILITIES
Liabilities arising from insurance contracts 568 464
Liabilities arising from reinsurance contracts 22 24
Financial liabilities
- Investment contracts at fair value through 691 604
profit and loss
- Borrowings at amortised cost 133 161
Deferred income tax 659 518
Deferred revenue 159 203
Provisions 43 36
Trade and other payables 568 522
Current income tax liabilities - 48
Total liabilities 2 843 2 580
Total equity and liabilities 7 550 6 792
Net asset value per share (cents) 875.9 796.0
Number of shares in issue (000`s) 537 393 529 134
Cash flow statement for the six months ended 31 December 2006
Group Group Group
Six months Six months Year
ended ended ended
December December June
2006 2005 2006
R million Unaudited Unaudited Audited
Health 389 327 798
Life (97) (64) (82)
Vitality 27 19 47
Holdings - (1) (6)
Destiny (17) (90) (66)
PruHealth (121) (73) (140)
181 118 551
Working capital changes 32 128 105
Cash generated by operations 213 246 656
Dividends received 17 15 33
Interest received 59 79 122
Interest paid (12) (5) (22)
Taxation paid (187) (83) (209)
Cash flow from operating activities 90 252 580
Cash flow from investing activities (388) (104) (138)
Net purchases of investments (332) (42) (46)
Purchases of property and equipment (37) (46) (59)
Proceeds on disposal of property and - - 1
equipment
Purchase of intangible assets (19) (16) (34)
Cash flow from financing activities (144) (33) (39)
Proceeds from issuance of ordinary 44 12 23
shares
Share issue costs written off - (2) (4)
against share capital
Dividends paid (160) - -
Dividends paid to Destiny Health - (1) (1)
preference shareholders
Minority share buy-back (3) - (6)
(Repayment)/increase of borrowings (25) 25 16
Redemption of Destiny preference - (67) (67)
shares
Net (decrease)/increase in cash and (442) 115 403
cash equivalents
Cash and cash equivalents at 1 322 916 916
beginning of year
Exchange gains on cash and cash 2 - 3
equivalents
Cash and cash equivalents at end of 882 1 031 1 322
year
Statement of changes in equity for the six months ended 31 December 2006
Attributable to equity holders of the Company
Reserve
for reva-
Share Share- luation
capital based of avail- Currency
and pay- able-for- trans-
share ment sale in- lation
R million premium reserve vestments reserve
31 December 2006
Balance at 1 July 2006 1 348 205 319 112
Issue of capital 39 - - -
Movement in share-based
payment reserve - 27 - -
Unrealised gains on - - 257 -
investments
Capital gains tax on
unrealised
gains on investments - - (34) -
Realised gains on
investments
transferred to income - - (40) -
statement
Capital gains tax on
realised
gains on investments - - 3 -
Translation of foreign - - - 3
subsidiary
Transfer from hedging - - - -
reserve
Profit for the period - - - -
Dividends paid - - -
Realised loss on minority
share buy-back - - - -
Balance at 31 December 2006 1 387 232 505 115
31 December 2005
Balance at 1 July 2005 1 336 20 209 98
Issue of capital 12 - - -
Share issue expenses (2) - - -
Movement in share-based
payment reserve - 157 - -
Unrealised gains on - - 174 -
investments
Capital gains tax on
unrealised
gains on investments - - (19) -
Realised gains on
investments
transferred to income - - (49) -
statement
Capital gains tax on
realised
gains on investments - - 7 -
Transfer from hedging - - - -
reserve
Translation of foreign - - - (2)
subsidiary
Profit for the period - - - -
Redemption of Destiny Health
preference shares - - - -
Balance at 31 December 2005 1 346 177 322 96
Attributable to equity holders of the Company
Hedging Retained Minority
R million reserve earnings interest Total
31 December 2006
Balance at 1 July 2006 4 2 224 - 4 212
Issue of capital - - (1) 38
Movement in share-based
payment reserve - - - 27
Unrealised gains on - - - 257
investments
Capital gains tax on
unrealised
gains on investments - - - (34)
Realised gains on
investments
transferred to income - - - (40)
statement
Capital gains tax on
realised
gains on investments - - - 3
Translation of foreign - - - 3
subsidiary
Transfer from hedging (7) - - (7)
reserve
Profit for the period - 403 1 404
Dividends paid - (155) - (155)
Realised loss on minority
share buy-back - (1) - (1)
Balance at 31 December 2006 (3) 2 471 - 4 707
31 December 2005
Balance at 1 July 2005 3 1 557 67 3 290
Issue of capital - - - 12
Share issue expenses - - - (2)
Movement in share-based
payment reserve - - - 157
Unrealised gains on - - - 174
investments
Capital gains tax on
unrealised
gains on investments - - - (19)
Realised gains on
investments
transferred to income - - - (49)
statement
Capital gains tax on
realised
gains on investments - - - 7
Transfer from hedging (3) - - (3)
reserve
Translation of foreign - - - (2)
subsidiary
Profit for the period - 194 - 194
Redemption of Destiny Health
preference shares - - (67) (67)
Balance at 31 December 2005 - 1 751 - 3 692
Segmental information for the six months ended 31 December 2006
Health
United
South States of United
R million Africa America Kingdom
31 December 2006
New business annualised premium income* 1 233 474 277
Gross inflows under management* 8 905 643 218
Income statement
Insurance premium revenue 75 485 109
Reinsurance premiums (1) (35) (3)
Fee income 1 006 - -
Investment income and gains 26 6 3
Vitality income - - -
Net income 1 106 456 109
Insurance benefits and claims (59) (363) (84)
Insurance claims recovered from 1 40 -
reinsurers
Acquisition costs - (22) (14)
Marketing and administration expenses (681) (130) (120)
Transfer from assets/liabilities under
insurance contracts 1 (8) (11)
Fair value adjustment to liabilities
under
investment contracts - - -
Expenses (738) (483) (229)
Profit from operations 368 (27) (120)
BEE expenses
Finance costs
Foreign exchange profit - unrealised
Share of profit from associates
Profit before taxation
Taxation
Profit for the year
31 December 2005
New business annualised premium income* 1 211 383 77
Gross inflows under management* 7 874 647 43
Income statement
Insurance premium revenue 9 436 21
Reinsurance premiums (2) (45) -
Fee income 922 - -
Investment income and gains 16 3 3
Vitality income - - -
Net income 945 394 24
Insurance benefits and claims (5) (379) (15)
Insurance claims recovered from - 40 -
reinsurers
Acquisition costs - (22) (2)
Marketing and administration expenses (659) (110) (72)
Transfer from assets/liabilities under
insurance contracts - - -
Fair value adjustment to liabilities
under
investment contracts - - -
Expenses (664) (471) (89)
Profit from operations 281 (77) (65)
BEE expenses
Finance costs
Profit before taxation
Taxation
Profit for the year
R million Life Vitality Total
31 December 2006
New business annualised premium income* 480 46 2 510
Gross inflows under management* 1 107 355 11 228
Income statement
Insurance premium revenue 1 107 - 1 776
Reinsurance premiums (253) - (292)
Fee income 1 - 1 007
Investment income and gains 169 6 210
Vitality income - 355 355
Net income 1 024 361 3 056
Insurance benefits and claims (446) - (952)
Insurance claims recovered from 220 - 261
reinsurers
Acquisition costs (443) (30) (509)
Marketing and administration expenses (211) (299) (1 441)
Transfer from assets/liabilities under
insurance contracts 343 - 325
Fair value adjustment to liabilities
under
investment contracts (95) - (95)
Expenses (632) (329) (2 411)
Profit from operations 392 32 645
BEE expenses (17)
Finance costs (11)
Foreign exchange profit - unrealised 1
Share of profit from associate 2
Profit before taxation 620
Taxation (216)
Profit for the year 404
31 December 2005
New business annualised premium income* 392 51 2 114
Gross inflows under management* 820 315 9 699
Income statement
Insurance premium revenue 820 - 1 286
Reinsurance premiums (182) - (229)
Fee income - - 922
Investment income and gains 197 4 223
Vitality income - 315 315
Net income 835 319 2 517
Insurance benefits and claims (282) - (681)
Insurance claims recovered from 161 - 201
reinsurers
Acquisition costs (382) (34) (440)
Marketing and administration expenses (182) (265) (1 288)
Transfer from assets/liabilities under
insurance contracts 293 - 293
Fair value adjustment to liabilities
under
investment contracts (76) - (76)
Expenses (468) (299) (1 991)
Profit from operations 367 20 526
BEE expenses (144)
Finance costs (10)
Profit before taxation 372
Taxation (178)
Profit for the year 194
* New business annualised premium income and gross inflows under management
include flows of the schemes Discovery administers and 100% of the business
conducted together with its joint venture partners.
Embedded value statement for the six months ended 31 December 2006
The embedded value of Discovery at 31 December 2006 is calculated as the sum of
the following components:
* the excess assets over liabilities at the valuation date (ie 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.
Prior to 31 December 2005, Life 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 required long-
term insurers to base the embedded value on the Statutory Valuation Method
(SVM). The key difference between the two bases for Life is that the value
capitalised in the assets under insurance contracts on the FSV basis may not be
reflected as an insurance asset under the SVM. The net asset value shown on the
published balance sheet has been adjusted to reflect the elimination of the
assets under insurance contracts as per the Life statutory accounts. The value
of the assets under insurance contracts on the FSV basis is released in the
value of in-force of the Statutory Valuation Method over time. The capital
maintained for Life throughout the projection term is based on the statutory
capital as defined by the SVM.
The value of new business is determined at the point of sale 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 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.
Table 1: Group embedded value
31 31 31 December % 30 June
December December
2006 2006
10 year 20 year
term for term for
Health and Health and
Vitality Vitality(1)
2005 change(2) 2006
R million
Shareholders` 4 707 4 707 3 692 27 4 212
funds
Elimination of
assets under
insurance (2 394) (2 394) (1 877) (2 088)
contracts
Shareholders`
funds excluding
assets under
insurance
contracts 2 313 2 313 1 815 2 124
Value of in-force
business
before cost of 9 793 10 956 8 466 8 774
capital
Cost of capital (132) (132) (201) (60)
Cost of STC(3) (262) (293) - (251)
Discovery Holdings
embedded value 11 712 12 844 10 080 16 10 587
Number of shares 537,4 537,4 529,1 533,4
(millions)
Embedded value per R21,79 R23,90 R19,05 14 R19,85
share
Diluted number of
shares (millions)
558,4 559,5 553,2 553,2
Diluted embedded
value per share(4)
R21,27 R23,29 R18,56 15 R19,47
(1) The term of the Health and Vitality projection is currently set at 10
years. There is significant value in the business after 10 years.
Since it is managements` intention to move to a 20 year projection
term for Health and Vitality in future, the results of the embedded
value based on the extended term is also shown. For the 20 year term
projection, the lapse rate assumption in the later years has been
increased. The analysis of the change in embedded value below is based
on a 10 year projection term. Note that the projection term of the
Destiny Health and Group Life products has not been increased.
(2) This shows the change in values between December 2005 and December
2006 based on a 10 year term for Health and Vitality.
(3) In line with Discovery`s current dividend policy, the cost of STC is
calculated assuming a 4.5 times dividend cover on the after-tax
profits as they emerge over the projection term. The total STC charge
has been allocated between the different business entities based on
their contribution to the total value of in-force. Prior to 2006,
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 31 December 2005 would have been R238 million on the same
basis.
(4) The diluted embedded value per share is calculated by increasing the
embedded value by the value of the loan to the Discovery Holdings
share trust, and by increasing the number of shares by the number of
shares issued to the share incentive trust which have not been
delivered to participants. An allowance has been made for Discovery`s
BEE transaction where the impact is dilutive i.e. where the current
embedded value per share exceeds the current transaction value.
Table 2: Value of in-force business
Value before Value after
cost of Cost of Cost of cost of
capital capital
R million and STC capital STC and STC
at 31 December 2006 - 10 year
term for
Health and Vitality
Health and Vitality 4 431 - (119) 4 312
Life(1) 5 330 (120) (142) 5 068
Destiny Health(2) 32 (12) (1) 19
Total 9 793 (132) (262) 9 399
at 31 December 2006 - 20 year
term for
Health and Vitality
Health and Vitality 5 594 - (150) 5 444
Life(1) 5 330 (120) (142) 5 068
Destiny Health(2) 32 (12) (1) 19
Total 10 956 (132) (293) 10 531
at 30 June 2006
Health and Vitality 4 258 - (122) 4 136
Life(1) 4 496 (45) (129) 4 322
Destiny Health 20 (15) (0) 5
Total 8 774 (60) (251) 8 463
(1) On the SVM basis, the Life cost of capital is based on a capital
adequacy requirement at December 2006 of R126 million. (June 2006: R94
million on the SVM basis).
(2) The values for Destiny Health reflect Discovery`s 98.12% shareholding
in Destiny Health at 31 December 2006.
Table 3: Group embedded value earnings
Six months ended Year ended
31 December 31 30 June
December
R million 2006 2005 2006
Embedded value at end of period 11 712 10 080 10 587
Less: Embedded value at beginning of period (10 587) (9 173) (9 173)
Increase in embedded value 1 125 907 1 414
Net issue of capital (38) (10) (12)
Dividends paid 155 - 1
Realised loss on minority share buy-back 1 - 1
Transfer to hedging reserve 7 3 (1)
Embedded value earnings 1 250 900 1 403
Annualised return on embedded value 25,0% 20,6% 15,3%
Table 4: Components of Group embedded value earnings
Six months ended Year ended
31 December 31 December % 30 June
R million 2006 2005 change 2006
Total profit from new
business
(at point of sale) 348 379 (8) 572
Profit from existing business
* Expected return 502 342 756
* Change in methodology and (52) (35) (540)
assumptions(1)
* Experience variances(2) 312 71 262
Acquisition costs(3) (49) (58) -
PruHealth and other new (112) (56) (128)
initiative costs
Adjustment for minority
interest in
Destiny Health (1) 3 10
Adjustment for Guardian
profit share
in Destiny Health(4) 15 (8) 1
Foreign exchange rate 2 (18) (4)
movements
Cost of STC 3 - -
Return on shareholders` 282 280 474
funds(5)
Embedded value earnings 1 250 900 39 1 403
(1) The change in methodology and assumptions item will vary over time to
reflect adjustments to the model and assumptions as a result of
changes to the operating and economic environment. The current
period`s changes are described in detail in Table 5 below (for
previous periods refer to previous embedded value statements). The
methodology and assumption changes for December 2006 are based on the
SVM method. The methodology and assumption changes for December 2005
and June 2006 are based on the FSV methodology.
(2) The experience variances for December 2006 are shown on the SVM
methodology. The experience variances for December 2005 and June 2006
are shown on the FSV methodology.
(3) A large proportion of Health and Vitality new business was written
over the period but only activated on 1 January 2007. Acquisition
costs of R32 million (December 2005: R45 million) arise in respect of
these members who are not included in the embedded value calculation.
Similarly acquisition costs of R7 million (December 2005: R13 million)
relate to Destiny Health and R10 million (December 2005: -) relate to
Life. These acquisition costs are not included in the calculation of
the value of new business.
(4) The agreement, in terms of which Guardian shares in 50% of the profits
from business written by Destiny Health prior to the agreement with
Guardian (i.e. non-alliance business), has been unwound.
(5) Return on shareholders` funds is shown net of tax and management
charges under the SVM method.
Table 5: Methodology and assumption changes for the six months ended 31 December
2006
Health and Destiny Health Life
Vitality
Net Value Net Value Net Value
worth of worth of worth of
R million in- in- in- Total
force force force
Modelling - - - - (1) (47) (48)
changes(1)
Cost of capital
modelling - - - - - (27) (27)
changes(2)
Economic - 22 - - (0) 114 136
assumptions
VAT assumption - (200) - - - - (200)
(3)
Benefit - - - - - (9) (9)
enhancements(4)
Expenses(5) - 78 - 27 1 (4) 102
Vitality - (11) - 3 - - (8)
benefits
Other - - - 2 - - 2
Total - (111) - 32 (0) 27 (52)
(1) The Life modelling changes primarily relate to the modelling of future
commission payments.
(2) The cost of capital modelling change primarily relates to a change in
the projection of future capital requirements and the costs associated
with future capital requirements. In addition, the cost of capital
now assumes that the capital adequacy requirement is backed by assets
consisting of 100% equities in all future periods. Previously, it was
assumed to be backed by assets consisting of 70% equities and 30%
fixed interest securities.
(3) This reflects an increase in the average VAT rate modelled.
(4) The Life benefit enhancements relate primarily to enhancements on the
Health Plan Protector product.
(5) The Health, Vitality and Destiny Health renewal expense assumption
change is based on the results of the most recent expense and budget
information.
Table 6: Experience variances for the six months ended 31 December 2006
Health and Destiny Health Life
Vitality
Net Value Net Value Net Value
worth of worth of worth of
R million in- in- in- Total
force force force
Renewal 20 - (7) - 1 - 14
expenses
Economic - 106 - - 0 (9) 97
assumptions
(1)
Extended - 123 - 3 - 3 129
modelling
term(2)
Lapses(3) 2 58 (2) (22) (4) 9 41
Cancella- - - - - 6 (42) (36)
tions(4)
Policy - 5 - 5 4 75 89
alterations
Premium - - (0) (28) (3) 8 (23)
increases
Mortality and - - (10) - 15 11 16
morbidity
Deferred - - - - 20 (20) -
profits
released
Tax (4) - - - (4) 4 (4)
Admin fees - - - - (1) - (1)
Other(5) 19 1 (4) (5) (29) 8 (10)
Total 37 293 (23) (47) 5 47 312
(1) The Health and Vitality economic assumptions variance reflects a
higher than expected administration and managed care inflationary
increase in 2007.
(2) The projection term for Health, Vitality, Destiny Health and Group
Life at 31 December 2006 has not been changed from the 10 year term
used at 30 June 2006. Thus, an experience variance arises because the
total term of the in-force business is effectively increased by six
months.
(3) Included in the Health and Vitality lapse experience variance is an
amount of R174 million in respect of members joining existing employer
groups during the period, offset by an amount of R160 million in
respect of members leaving existing employer groups. A positive
variance of R46 million is due to lower than expected lapses.
(4) Backdated cancellations are in respect of policies cancelled to the
inception date with a corresponding refund of premiums.
(5) Other variances for Life primarily relate to timing differences
between projected and actual cashflows.
Table 7: Embedded value of new business
Six months ended Year
ended
30 June
2006
31 31 31 %
December December December
2006 2006 2005
10 year 20 year
term for term for
Health Health
and and
Vitality Vitality
Change
(1)
R million
Health and Vitality
Gross profit from new
business
at point of sale 44 69 60 115
Cost of capital - - - -
Cost of STC (2) (4) - (3)
Net profit from new
business
at point of sale 42 65 60 (30) 112
New business annualised
premium income(2) 370 370 369 0 1 121
Life
Gross profit from new
business
at point of sale 374 374 332 532
Cost of capital (18) (18) (27) (7)
Cost of STC (10) (10) - (15)
Net profit from new
business
at point of sale 346 346 305 13 510
New business annualised
premium income(3) 359 359 276 30 592
Annualised profit 10,7% 10,7% 13,3% 10,8%
margin(4)
Destiny Health
Gross profit from new
business
at point of sale (40) (40) 15 (50)
Cost of capital (0) (0) (1) (0)
Cost of STC 0 0 - 0
Net profit from new
business
at point of sale(5) (40) (40) 14 (50)
New business annualised
premium income(2) 219 219 246 (11) 457
New business annualised
premium income (US$ 30 30 38 (21) 71
million)
(1) This shows the change in values between December 2005 and December
2006 based on a 10 year term for Health and Vitality.
(2) 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 31
December 2006.
The total Health and Vitality new business annualised premium income
written over the period was R1 279 million (December 2005: R1 262
million).
For Destiny Health, the total new business annualised premium income
written over the period was R474 million (December 2005: R383
million).
(3) 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 R359 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 R72 million and servicing increases of R49
million was R480 million. Single premium business is included at 10%
of the value of the single premium.
Discovery Retirement Optimisers added to existing Life Plans have been
included in the value of new business.
(4) The annualised profit margin is the value of new business expressed as
a percentage of the present value of future premiums.
(5) The Destiny Health value of new business allows for the actual new
business expenses incurred over the past six months. This value
includes acquisition costs in respect of Tufts new business written
over the past six months which is expected to run-off over the next
year.
Table 8: Embedded value assumptions
31 December 31 December 30 June
2006 2005 2006
Risk discount rate (%)
- Health and Vitality 11,25 10,25 12,00
- Life 11,25 10,25 12,00
- Destiny Health 10,00 10,00 10,00
Medical inflation (%)
South Africa 7,25 6,75 8,00
United States 13,00 Current Current
levels levels
reducing to reducing to
12.50% 13.00%
over the over the
projection projection
period period
Expense inflation (%)
South Africa 4,25 3,75 5,00
United States 3,00 3,00 3,00
Pre-tax investment return (%)
South Africa - Cash 6,75 5,75 7,50
- Bonds 8,25 7,25 9,00
- Equity 10,25 9,25 11,00
United States 3,00 3,00 3,00
- Bonds
Dividend cover ratio 4,5 times - 4,5 times
Income tax rate (%)
- South Africa 29,00 29,00 29,00
- United States Federal Tax Rate(1) 34,00 34,00 34,00
(1) Various additional State taxes also apply
Life mortality, morbidity and lapse assumptions were derived from
internal experience, where available, augmented by reinsurance and
industry information.
The Health lapse assumptions were based on the results of recent
experience investigations. The lapse rate for the projection term
after 10 years was increased above current experience.
The Destiny Health morbidity and lapse assumptions were based on the
results of recent experience investigations.
Renewal expense assumptions were based on the results of the latest
expense and budget information.
A notional allocation of corporate overhead expenses has been made to
each of the subsidiary companies based on managements` view of each
subsidiary`s contribution to overheads.
The investment return assumption was based on a single interest rate
derived from the risk free zero coupon yield curve. Other economic
assumptions were set relative to this yield. The risk discount rate
has been set relative to the risk-free rate, increased by a risk
premium. The current and projected tax position of the policyholder
funds within the Life company has been taken into account in
determining the net investment return assumption.
It was assumed that the capital adequacy requirements in future years
will be backed by surplus assets consisting of 100% equities for the
purposes of calculating the cost of capital at risk. Allowance has
been made for tax and investment expenses in the calculation of the
cost of capital.
Review of Group results
Gross inflows under management increased 16% for the six months ended 31
December 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
December December % change
2006 2005
R million R million
Discovery Health 8 905 7 874 13
Discovery Life 1 107 820 35
Discovery Vitality 355 315 13
Destiny Health 643 647 (1)
PruHealth 218 43
Gross inflows under management 11 228 9 699 16
Less: collected on behalf of third (8 090) (7 176)
parties
Discovery Health (7 824) (6 943)
Destiny Health (157) (211)
PruHealth (109) (22)
Gross income of Group 3 138 2 523 24
Earnings
The following table shows the main components of the increase in Group profit
from operations excluding investment income for the six months:
Earnings source
December December % change
2006 2005
R million R million
Discovery Health 342 265 29
Discovery Life 318 246 29
Discovery Vitality 26 16 63
Destiny Health (33) (80) 59
PruHealth (123) (68) (81)
Group operating profit before investment 530 379 40
income
Investment income 77 97 (21)
Realised and unrealised gains and losses 133 126 6
Fair value adjustment to liabilities (95) (76) (25)
under investment contracts
Profit from operations before BEE expense 645 526 23
Headline Earnings
Headline earnings increased by 29% excluding the impact of the BEE transaction.
Unrealised gains of R257 million on available-for-sale investments for the six
months 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:
December December % change
2006 2005
R million R million
Net profit attributable to equity 403 194 108
shareholders
Adjustment for realised profit on
available-for-sale
investments net of CGT (37) (42)
Headline earnings 366 152 141
BEE expenses 17 144
Headline earnings before BEE transaction 383 296 29
Headline earnings per share before BEE
transaction (cents)*:
- undiluted 71,6 56,1 28
- diluted 70,1 54,3 29
Headline earnings per share (cents):
- undiluted 68,4 28,8 138
- diluted 65,9 28,3 133
* 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.
Balance Sheet
The increase in the assets arising from insurance contracts of R349 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.
Subsequent to 31 December 2006, PruHealth entered into a reinsurance contract
which will have the effect of reducing PruHealth`s capital requirements.
Share-based payments
The special purpose vehicles and trusts to which Discovery issued 38,7 million
shares in terms of its BEE transaction, 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 BEE transaction has resulted in a charge to the income statement of R17
million in the 6 month period ended 31 December 2006 (December 2005: R144
million) in accordance with the requirements of IFRS 2.
An additional R26 million (December 2005: R13 million) in respect of options
granted under employee share incentive schemes has been expensed in the income
statement for the six months in accordance with the requirements of IFRS 2.
Accounting policies
The interim financial statements have been prepared in accordance with IFRS as
well as the South African Companies Act 61 of 1973, as amended, and are
consistent with the accounting policies applied in the previous financial
reporting period.
The interim financial statements do not include all of the information required
for full annual financial statements.
Directorate
Mr PK Harris was appointed as a non-executive director to the board of Discovery
with effect from 15 February 2007.
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
R126,4 million (2005: R96,1 million) and were covered 12,4 times (2005: 12,5
times).
Dividend declaration
The board has declared a dividend of 16 cents per share. The salient dates are
as follows:
- Last date to trade "cum" dividend Friday, 23 March 2007
- Date trading commences "ex" dividend Monday, 26 March 2007
- Record date Friday, 30 March 2007
- Date of payment Monday, 2 April 2007
Share certificates may not be dematerialised or rematerialised between Monday,
26 March 2007 and Friday, 30 March 2007, both days inclusive.
www.discovery.co.za
Date: 22/02/2007 09:08:01 Produced by the JSE SENS Department.
