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Discovery - Announcement Discovery Holdings Limited (Incorporated in the Republic of South Africa) (Registration number 1999/007789/06) Share code: DSY ISIN: ZAE000022331 ("Discovery" or "the company") Effect of the resolution of outstanding issues on Discovery`s embedded value Introduction On 24 May 2002 Discovery, Discovery Health, Discovery Health Medical Scheme ("DHMS") and the Registrar and Council for Medical Schemes reached resolution on outstanding issues. The following items were agreed between the parties and will have a financial impact on Discovery: - the administration fee charged by Discovery Health to DHMS has decreased from 14% to 12.4% with effect from 1 January 2002; - future administration and managed care fees will increase in line with the Consumer Price Index until 31 December 2004; - the quota share reinsurance percentage between Discovery Life and DHMS has decreased from 67% to 33% with effect from 1 January 2002, and a profit share agreement has been introduced. In addition, the following changes have been made to DHMS`s reinsurance arrangements for 2002: - 3.4% of the DHMS contribution will be used exclusively for the accumulation of statutory reserves in DHMS. The quota share reinsurance premium will not include this solvency margin, and will not share in the reduced administration fees payable; and - DHMS will purchase stop-loss reinsurance from Discovery Life. Discovery`s embedded value as at 31 December 2001 has been recalculated for illustrative purposes, changing only those items that are materially impacted by the resolution. Full details of the effect of the resolution on Discovery`s earnings, net asset value and embedded value per share will be disclosed in the annual profit announcement to be published towards the end of August 2002. Illustrative embedded value statement Group consolidated embedded value statement R`000 R`000 %
At 31/12/01 At 31/12/01 change Illustrative , after resolution
Local shareholders` funds 915.6 915.6 Destiny Health Inc. start- 146.5 146.5 up cost Total value of 1,062.1 1,062.1 shareholders` funds Value of current business 2,046.7 2,793.9 (27) Cost of capital (82.9) (115.6) (28) Total embedded value 3,025.9 3,740.4 (19) Total embedded value 3,025.9 3,740.4 (19) Number of shares in issue 390.6 390.6 (`000) Embedded value per share R7.75 R9.58 (19) Diluted embedded value per R7.69 R9.52 (19) share Embedded value of new business Health and Vitality R`000 R`000 % 6 months to 6 months to change 31/12/01 31/12/01 Illustrative , after
resolution Gross profit from new 119.8 186.3 (36) business at point of sale Cost of capital (5.7) (9.9) (43) Net profit from new 114.1 176.4 (35) business at point of sale Experience variances and 27.8 27.6 1 expected return Net profit from new 141.9 204.0 (30) business at valuation date Life Gross profit from new 99.2 99.2 business at point of sale Cost of capital (12.2) (5.7) (112) Net profit from new 87.0 93.5 (7) business at point of sale Experience variances and 6.8 6.8 expected return Net profit from new 93.8 100.3 (6) business at valuation date Review of embedded value statement The illustrative calculation of the resolution results in a 19% decrease in the embedded value for the six months to 31 December 2001, from R3740,4 million to R3025,9 million. Embedded value per share falls from R9,52 per share to R7,69 per share. There has been a 27% fall in the value of in force business due to the reduced administration fee income and the future link to the Consumer Price Index. Net profit from new Health and Vitality business has fallen by 35%, as no changes have been made to the initial expenses incurred and used in the 31 December 2001 embedded value calculation. The value of shareholder`s funds has not been recalculated. The health insurance durational and AIDS reserves will be recalculated during the annual year-end valuation. No allowance for the stop loss contract has been made in the calculation of the embedded value or the capital adequacy requirement. Changes to the embedded value calculation and assumptions used The following changes have been made to the calculation of the value of in force business and the value of new business: - the administration fee has decreased from 14% to 12.4% with effect from 1 January 2002; - it is assumed that administration fee income, managed care fee income and commission outgo will increase for all future years at the expense inflation rate, rather than the medical inflation rate. The link to expense inflation rather than medical inflation represents a conservative approach to allowing for the capping of administration fees to the CPI inflation rate until 31 December 2004; - the quota share reinsurance percentage has decreased from 67% to 33%. The underlying claim rate has not changed from that used in past embedded value calculations, and represents a rate higher than that currently experienced; - the per member renewal expense assumption has been lowered by 2% to allow for the lower cost base and economies of scale in the future, based on current expense budgets. The lower quota share reinsurance percentage has reduced the capital adequacy requirement and the cost of capital for the health product. However, the consolidated group capital adequacy requirement has not decreased in line with the reduction in the health capital adequacy requirement, and therefore the cost of capital for the life product has increased. The value for the cost of capital shown above also includes some refinements to the models used for projecting the run-off of the capital adequacy requirement. The following table illustrates the economic assumptions used: 31/12/01 31/12/001 Illustrati (%) ve, after
the resolution (%) Risk discount rate - Health and Vitality 16.5 16.5 - Pre-funding 15.0 15.0 - Life product 15.0 15.0 Medical inflation 10.5 10.5 Expense inflation - Health and Vitality 9.0 9.0 - Pre-funding 8.0 8.0 - Life product 8.0 8.0 Tax rate 30.0 30.0 The changes to the embedded value have been reviewed by QED Actuaries and Consultants (formerly Hymans Robertson and Company). They confirm that that the methodology and assumptions used to determine the embedded value are reasonable and consistent with those used in the most recent annual financial statements. Sandton 26 June 2002 Merchant bank and sponsor Corporate Law Advisor RMB ENF Date: 26/06/2002 07:36:30 AM Produced by the SENS Department
