Wrap Text
Discovery - Unaudited interim financial results for the six months ended 31
December 2005
DISCOVERY HOLDINGS LIMITED
(Incorporated in the Republic of South Africa)
(Registration number: 1999/007789/06)
ISIN: ZAE000022331
Share Code: DSY
("Discovery")
Unaudited interim financial results for the six months ended 31 December 2005
- Operating profit + 32% to R526 million
- Post-tax profits + 73%, after BEE deal - 1%
- New business of R2.1 billion
- Embedded value +27% to R10 billion
Financial results for the six months ended 31 December 2005
Discovery"s core purpose is to make people healthier and enhance and protect
their lives. Discovery"s business model revolves around our ability to
understand consumer needs and develop products that meet them, positioning
Discovery well to capitalise on the world-wide trend towards consumerism. The
result is a modern insurance organisation that has grown organically through
four distinct businesses built around people"s needs.
During the six months under review, we have worked hard to drive this people-
centred vision in our local businesses. Discovery Health"s consumer-driven
healthcare model provides the platform for health assurance products that place
consumers in control of their health care spending. In the case of Discovery
Life, we have responded to consumers" demand for flexible life assurance
products that meet their benefit expectations. In our international operations,
Destiny Health and PruHealth, our focus has been on unlocking our unique
consumer-driven health care capability in the context of new, global markets.
Operating profits for the group grew strongly by 32% during the period under
review to R526m (2004: R399m), despite a disappointing performance from Destiny
Health and before the once-off expense associated with our recent BEE
transaction. PruHealth grew strongly and in line with expectations, achieving
the 35 000 client milestone as forecast. Discovery Health"s annualised new
business premium grew by 8%, off a high base, while Discovery Life achieved new
business growth of 18% and a 29% increase in profit.
PruHealth
In October 2004, we launched PruHealth in partnership with the Prudential plc,
with the aim of creating a company that would lead the trend towards consumerism
in the UK private medical insurance market. To date, PruHealth"s performance has
been exceptional. The investment in PruHealth of R68m (2004: R80m) and new
business growth of R77m (2004: R5m) over the period were in line with our
forecasts.
The growth in PruHealth"s distribution footprint and operational capability has
exceeded our expectations. We believe this reflects the combination of an
elegant, easy-to-use product that is attractive to consumers on the one hand
and, on the other, the rapid, effective roll-out of Discovery"s operational
framework to support product distribution and operations. PruHealth has quickly
developed a nation-wide Vitality footprint, providing clients with access to
Vitality wellness benefits across the UK. We have also been encouraged by the
significant broker support across the market by well-known intermediary brands
and PruHealth"s ability to attract young and healthy lives.
This combination of product and back-office efficiency has allowed us to gain a
significant competitive price advantage, further bolstering our growth
opportunities. The result is a business of exceptional quality that, despite its
small size, has proven its ability to compete against traditional, established
players, generating strong new business flows at an acceptable medical loss
ratio. Based on its strong foundational position, we are cautiously optimistic
of the outlook for PruHealth and have set a bold short-term goal of 100,000
lives by 1 January 2007.
Destiny Health
To our disappointment, the period under review saw further operational losses of
R80m (2004: R41m) for Destiny Health. While new business growth has been strong
in the Mid-Atlantic, Wisconsin and Massachusetts markets, the underlying market
dynamics in Illinois have negatively impacted Destiny. The operating losses
incurred are attributable to slower-than-anticipated expansion into new markets
and an over-concentration in the Illinois market, where a significant pricing
disadvantage exists relative to the dominant insurer in that market. This placed
Destiny under increasing price pressure, resulting in increased lapses and
underwriting losses during the period under review. Destiny Health"s progress in
the three other markets it competes in has demonstrated that our focus must be
on rapid expansion into new markets and on providing the technical sales
infrastructure to support new business growth in these new markets.
The strategy which has exposed Destiny to a concentration of risk within the
Illinois market has been addressed during the period under review with a view to
rapidly reversing the negative financial trend in Destiny"s results. Premiums
have been significantly increased at policy renewal dates and expansion plans
have been accelerated to address the claims losses and market concentration in
Illinois. Initial results are promising: the rates adjustments are translating
into lower loss ratios with target retention rates having been achieved and we
have been operational in the Texas market since 31 January 2006, where we have
received a positive response.
The category of consumer-driven health care is gaining increasing support in the
US, especially at a national health policy level, creating favourable conditions
for Destiny Health; this is especially true of the Texas market. Combined with
the power of Discovery"s consumer-driven health care capability and our joint
ventures with Guardian and Tufts Health Plan, we believe there are significant
opportunities for Destiny Health in the year ahead.
A rigorous, disciplined approach to the measurement and evaluation of Destiny"s
progress is being applied on a quarterly basis. The immediate short-term target
is to achieve a run-rate of 3,000 new members per month and consistently improve
quarter-on-quarter financial results. We remain cautiously optimistic that the
achievement of these goals will lead to a viable business and profitability in
the medium term.
Discovery Health
Discovery Health continues to deliver robust growth and financial performance
with operating profit increasing by 9% to R266m (2004: R245m), despite a
reduction in real terms of administration fees and loss of re-insurance income
over time. The combined membership of the schemes under Discovery Health"s
administration grew to 1,883,879 as at 1 January 2006 (2005: 1,704,240
members). This reflects continued growth in new business to R1211m (2004:
R1175m) - which, coming off a high base has exceeded our expectations - as well
as a reduction in the lapse rate to 3.3% (2004: 3.7%).
Over the last 13 years, Discovery Health has demonstrated a capability to
deliver innovative products that empower the consumer combined with the ability
to navigate a complex, evolving regulatory environment. Going forward, Discovery
Health must use its leadership position to ensure access to the best quality of
care for its members. This is a function of Discovery Health"s unmatched scale,
which in the period under review manifested in the launch of the Discovery 911
emergency response network, the Discovery Hospital Rating Index (an objective
cost and quality assessment tool,) as well as successful negotiations with
various provider groups to contain cost increases into 2006. Evidence is also
starting to emerge establishing the value of Vitality"s role in lowering health
care costs.
By combining its scale and focus on lowering health care spend by promoting
healthy lifestyles, Discovery Health is able to operate at a discount to its
competitors. Coupled with its unique footprint and the quality of its client
base, Discovery Health is well-positioned to continue delivering growth and more
affordable access to quality health care in its existing market. In addition,
these attributes position Discovery Health well to capitalise on developments in
the emerging and low income markets. Discovery"s KeyCare product (aimed at the
R3 500-R6 500 income market) now exceeds 100,000 members, more than half of
which are new entrants to the private healthcare industry and the development of
Discovery Health"s primary care network has progressed well with over 1,500
doctors now represented within the network.
Operationally, Discovery Health"s performance is at the best levels ever - from
service to customer retention to the ability to manage costs on behalf of our
members. A significant focus has been applied to improving efficiencies and
enhancing service further during the period under review. The front-line
servicing and back-office operations, representing over 2,000 staff members,
have recently been merged to support this strategy and generate annualised
administrative savings in excess of R50 million over the next 12 months.
Discovery Life
Discovery Life"s performance has exceeded expectations with operating profit
growing 29% to R246m (2004: R190m) and new business growing 18% to R392m (2004:
332%). Unlike other players in the market who employ a banc assurance model that
centres on investments and cross-selling, Discovery Life has adopted a "health-
assurance" model. This model integrates our health management capabilities with
Discovery"s risk management expertise. The ability to accurately price health
risk and encourage health improvements through integration with Vitality and
Discovery Health, has translated into better-than-expected mortality and
morbidity rates, resulting in exceptional growth in underwriting profits during
the period under review from R126m to R216m.
The same health insurance mindset has informed our entry into the investment
market with the Discovery Life retirement Optimiser. The Optimiser makes use of
"unneeded" life assurance post-retirement to fund much needed retirement income
and provides real guarantees regarding benefit expectations. We are already
seeing the Optimiser gain traction, with an estimated 17% of the retirement
funding business written by independent brokers being written with Discovery
Life, just six months after the launch of the Optimiser product.
We are cautiously optimistic about Discovery Life"s future prospects.
In addition to growing its primary risk assurance business by continuing to
leverage the integration opportunities with other Discovery products and
businesses, Discovery Life will aim to solidify its entry into the retirement
funding market by securing 20% of the independent broker new business market
during the current financial year.
The future
While each of Discovery"s businesses is at a different stage of its evolution,
we are cautiously optimistic of their future growth prospects.
PROSPECTS
All of Discovery"s businesses are well positioned for strong growth going
forward without requiring recourse to additional capital.
By order of the board
LL Dippenaar A Gore
Chairman Chief Executive Officer
22 February 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
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 2005
Group Group Group
Six months Six months Year
ended ended ended
December December June
2005 2004 % 2005
R million Unaudited Unaudited change Audited
Premium income 1 277 824 1 820
Other income 1 246 1 016 2 209
Gross income of Group 2 523 1 840 4 029
Outward reinsurance
premiums (229) (145) (378)
Investment income 105 85 124
Realised and unrealised
gains and losses 118 82 157
Net income 2 517 1 862 3 932
Policyholder benefits (681) (370) (841)
Recoveries from
reinsurers 201 99 262
Net policyholder
benefits (480) (271) (579)
Acquisition costs (440) (363) (714)
Operating and
administration
expenses (1 288) (1 034) (2 166)
Transfer from
assets/liabilities
under insurance
contracts 293 296 574
Fair value adjustment
to liabilities under
investment contracts (76) (91) (122)
Profit from operations
after BEE expenses 526 399 32 925
Local operations 668 517 1 154
Foreign operations (142) (118) (229)
BEE expenses (144) - -
Profit from operations
after BEE expenses 382 399 925
Financing costs (10) (28) (64)
Foreign exchange loss -
unrealised - (33) (8)
Profit before taxation 372 338 10 853
Taxation (178) (143) (305)
Profit after taxation 194 195 (1) 548
Attributable to:
Ordinary shareholders 194 195 557
Minority shareholders - - (9)
194 195 548
Basic earnings per
share (cents)
- undiluted 36,8 37,7 (2) 107,3
- diluted 35,9 36,7 (2) 103,0
Weighted number of
shares in issue
(000"s) 528 468 518 793 519 188
Diluted weighted number
of shares (000"s) 553 749 549 271 553 227
BALANCE SHEET
at 31 December 2005
Group Group
December June
2005 2005
R million Unaudited Audited
ASSETS
Cash and cash equivalents 1 031 916
Money market
- available-for-sale 55 53
- at fair value through profit and loss 110 106
Government and public authority stocks
- available-for-sale 147 146
- at fair value through profit and loss 49 40
Equity investments
- available-for-sale 1 142 922
- at fair value through profit and loss 407 337
Investment in associate 7 4
Investment assets 2 948 2 524
Loans and receivables 483 557
Deferred taxation 43 35
Assets arising from insurance contracts 2 186 1 881
Intangible assets 49 45
Property and equipment 216 219
Total assets 5 925 5 261
LIABILITIES AND SHAREHOLDERS" FUNDS
Liabilities
Trade and other payables 995 951
Provisions 31 30
Taxation 37 17
Deferred taxation 421 323
Financial liabilities 710 619
- Investment contracts at fair
value through profit and loss 554 483
- Borrowings at amortised cost 156 136
Liabilities arising from
insurance contracts 12 -
Liabilities arising from
reinsurance contracts 27 31
Total liabilities 2 233 1 971
Shareholders" funds
Share capital and share premium 1 346 1 336
Reserves 2 346 1 887
3 692 3 223
Minority interest - 67
Total shareholders" funds 3 692 3 290
Total liabilities and shareholders" funds 5 925 5 261
CASH FLOW STATEMENT
for the six months ended 31 December 2005
Group Group Group
Six months Six months Year
ended ended ended
December December June
2005 2004 2005
R million Unaudited Unaudited Audited
Health 327 316 691
Life (64) 80 25
- operating activities (64) (120) (175)
- quota share deposit - 200 200
Vitality 19 15 52
Holdings (1) - (1)
Destiny (90) (27) (42)
PruHealth (73) (77) (150)
Cash generated by operations 118 307 575
Working capital changes 128 (41) 10
246 266 585
Dividends received 15 11 23
Interest received 79 40 72
Financing costs (5) (3) (93)
Taxation paid (83) (114) (179)
Cash flow from operating
activities 252 200 408
Cash flow from investing
activities (104) (67) (210)
Investment purchases (249) (109) (801)
Proceeds on disposal of
investments 207 91 724
Purchase of equipment (46) (36) (106)
Purchase of intangible assets (16) (16) (30)
Decrease in loans receivable - 3 3
Cash flow from financing
activities (33) 59 (134)
Proceeds from shares issued 12 18 71
Share issue costs written off
against share capital (2) (1) (1)
Dividends paid to Destiny Health
preference shareholders (1) - (1)
Minority share buy-back - (1) (1)
Increase/(decrease) in borrowings 25 43 (202)
Redemption of Destiny preference
shareholders (67) - -
Net increase in cash and cash
equivalents 115 192 64
Cash and cash equivalents at
beginning of year 916 845 845
Effects of exchange rate changes
on cash and cash equivalents - (8) 7
Cash and cash equivalents at
end of year 1 031 1 029 916
STATEMENT OF CHANGES IN EQUITY
for the six months ended 31 December 2005
Attributable to ordinary shareholders
Share Share-
capital and based Invest- Trans-
share payment ment lation
R million premium reserve reserve resesrve
31 December 2005
Balance at 1 July 2005 1 336 20 209 98
Issue of capital 12 - - -
Share issue expenses (2) - - -
Net profit for the period - - - -
Movement in share-based
payment reserve - 157 - -
Unrealised gains on
investments - - 155 -
Realised gains on
investments transferred
to income statement - - (42) -
Revaluation of forward
exchange contract - - - -
Translation of foreign
subsidiary - - - (2)
Redemption of Destiny
Health preference shares - - - -
Balance at
31 December 2005 1 346 177 322 96
31 December 2004
Balance at 1 July 2004 1 276 - 51 69
Issue of capital 18 - - -
Share issue expenses (1) - - -
Movement in share-based
payment reserve - 7 - -
Net profit for the period - - - -
Dividends paid to Destiny
Health preference
shareholders - - - -
Unrealised gains on
investments - - 163 -
Realised gains on
investments transferred
to income statement - - (15) -
Revaluation of forward
exchange contract - - - -
Translation of foreign
subsidiary - - -
Balance at
31 December 2004 1 293 7 199 78
*Amount is less than R500 000
STATEMENT OF CHANGES IN EQUITY
for the six months ended 31 December 2005
Attributable to
ordinary
shareholders
Hedging Retained Minority
R million reserve earnings interest Total
31 December 2005
Balance at 1 July 2005 3 1 557 67 3 290
Issue of capital - - - 12
Share issue expenses - - - (2)
Net profit for the period - 194 - 194
Movement in share-based
payment reserve - - - 157
Unrealised gains on
investments - - - 155
Realised gains on
investments transferred
to income statement - - - (42)
Revaluation of forward
exchange contract (3) - - (3)
Translation of foreign
subsidiary - - - (2)
Redemption of Destiny
Health preference shares - - (67) (67)
Balance at
31 December 2005 - 1 751 - 3 692
31 December 2004
Balance at 1 July 2004 (6) 1 002 67 2 459
Issue of capital - - - 18
Share issue expenses - - - (1)
Movement in share-based
payment reserve - - - 7
Net profit for the period - 195 - 195
Dividends paid to Destiny
Health preference
shareholders - (1) - (1)
Unrealised gains on
investments - - - 163
Realised gains on
investments transferred
to income statement - - - (15)
Revaluation of forward
exchange contract 6 - - 6
Translation of foreign
subsidiary - - - 9
Balance at
31 December 2004 - 1 196 67 2 840
*Amount is less than R500 000
SEGMENTAL INFORMATION
for the six months ended 31 December 2005
Health
United
South States of United
R million Africa America Kingdom Life
31 December 2005
New business annualised
premium income 1 211 383 77 392
Gross inflows under
management 7 874 647 43 820
Income statement
Gross income of Group 931 436 21 820
Outward reinsurance
premiums (2) (45) - (182)
Investment income 15 3 3 79
Realised and unrealised
gains and losses - - - 118
Net policyholder benefits (5) (339) (15) (121)
Acquisition costs - (22) (2) (382)
Operating and administration
expenses (658) (110) (72) (182)
Transfer from assets/
liabilities arising
from insurance contracts - - - 216
Fair value adjustments
to liabilities under
investment contracts - - - (76)
Return on assets arising
from insurance contracts - - - 77
Profit/(loss) from
operations before
BEE expenses 281 (77) (65) 367
BEE expenses
Financing costs
Profit before taxation
Cash flow statement
Cash generated by
operations 327 (90) (73) (64)
Cash flow from financing
activities - (39) - -
31 December 2004
New business annualised
premium income 1 175 409 5 332
Gross inflows under
management 6 884 375 * 587
Income statement
Gross income of Group 782 237 * 587
Outward reinsurance
premiums (2) (3) - (140)
Investment income 17 1 2 61
Realised and unrealised
gains and losses - - - 82
Net policyholder benefits (3) (171) * (97)
Acquisition costs - (20) * (325)
Operating and administration
expenses (532) (84) (80) (131)
Transfer from assets/
liabilities under
insurance contracts - - - 232
Fair value adjustment to
liabilities under investment
contracts - - - (91)
Return on assets arising
from insurance contracts - - - 64
Profit/(loss) from
operations 262 (40) (78) 242
Financing costs
Foreign exchange loss -
unrealised
Profit before taxation
Cash flow statement
Cash generated by
operations 316 (27) (77) 80
Cash flow from financing
activities - 42 - -
*Amount is less than R500000.
SEGMENTAL INFORMATION
for the six months ended 31 December 2005
R million Vitality Holdings Total
31 December 2005
New business annualised premium
income 51 - 2 114
Gross inflows under management 315 - 9 699
Income statement
Gross income of Group 315 - 2 523
Outward reinsurance premiums - - (229)
Investment income 4 1 105
Realised and unrealised gains
and losses - - 118
Net policyholder benefits - - (480)
Acquisition costs (34) - (440)
Operating and administration expenses (265) (1) (1 288)
Transfer from assets/liabilities
arising from insurance contracts - - 216
Fair value adjustments to
liabilities under investment
contracts - - (76)
Return on assets arising from
insurance contracts - - 77
Profit/(loss) from operations before
BEEexpenses 20 - 526
BEE expenses (144)
Financing costs (10)
Profit before taxation 372
Cash flow statement
Cash generated by operations 19 (1) 118
Cash flow from financing activities - 6 (33)
31 December 2004
New business annualised premium
income 36 - 1 957
Gross inflows under management 234 - 8 080
Income statement
Gross income of Group 234 - 1 840
Outward reinsurance premiums - - (145)
Investment income 4 - 85
Realised and unrealised gains
and losses - - 82
Net policyholder benefits - - (271)
Acquisition costs (18) - (363)
Operating and administration expenses (207) - (1 034)
Transfer from assets/liabilities
under insurance contracts - - 232
Fair value adjustment to liabilities
under investment contracts - - (91)
Return on assets arising from
insurance contracts - - 64
Profit/(loss) from operations 13 - 399
Financing costs (28)
Foreign exchange loss - unrealised (33)
Profit before taxation 338
Cash flow statement
Cash generated by operations 15 - 307
Cash flow from financing activities - 17 59
*Amount is less than R500 000.
FINANCIAL COMMENTARY
REVIEW OF GROUP RESULTS
Gross inflows under management increased 20% for the six months ended 31
December 2005. Gross inflows under management includes flows of the schemes
Discovery administers and 100% of the business conducted together with its joint
venture partners.
December December
2005 2004 %
Gross inflows under
management R million R million change
Discovery Health 7 874 6 884 14
Discovery Life 820 587 40
Discovery Vitality 315 234 35
Destiny Health 647 375 73
PruHealth 43 - -
Gross inflows under
management 9 699 8 080 20
Less: collected on behalf of
third parties (7 176) (6 240)
Discovery Health (6 943) (6 102)
Destiny Health (211) (138)
PruHealth (22) -
Gross income of Group 2 523 1 840 37
EARNINGS
The following table shows the main components of the increase in profit from
operations before BEE expense for the six months:
December December
2005 2004 %
Earnings source R million R million change
Discovery Health 266 245 9
Discovery Life 246 190 29
Discovery Vitality 16 9 78
Destiny Health (80) (41) (95)
PruHealth (68) (80) 15
Discovery Holdings (1) - -
Profit from operations before
investment income 379 323 17
Investment income 105 85
Realised and unrealised gains
and losses 118 82
Fair value adjustment to
liabilities under investment
contracts (76) (91)
Profit from operations before
BEE expense 526 399 32
HEADLINE EARNINGS
Headline earnings in compliance with International Financial Reporting Standards
(IFRS) increased by 64%, excluding the impact of the BEE transaction.
Unrealised gains of R155 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
2005 2004 %
R million R million change
Net profit attributable to
ordinary shareholders pre IFRS
and other adjustments 356 206 73
Adjustments for:
IFRS 2: Share-based payments (157) (7)
Leases (5) (4)
Net profit attributable to
ordinary shareholders post
IFRS and other adjustments 194 195 (1)
Adjustment for realised profit
on available-for-sale
investments net of CGT (42) (15)
Headline earnings 152 180 (16)
Headline earnings per share
(cents):
- undiluted 28,8 34,7 (17)
- diluted 28,3 33,9 (17)
Headline earnings before BEE
transaction 296 180 64
Headline earnings per share
before BEE transaction (cents):
- undiluted 56,1 34,7 62
- diluted 54,3 33,9 60
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
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 R305 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 period, 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 R144 million in the six-month period ending 31 December 2005. This
charge represents the financial effects of the BEE transaction.
An additional R13 million in respect of options granted under employee share
incentive schemes has been expensed in the income statement 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, 1973. This may differ from IFRS
actually in effect at 30 June 2006 as a result of ongoing review and possible
amendment by interpretive guidance from the International Accounting Standards
Board and IFRIC and may therefore be subject to change.
These are Discovery"s first IFRS interim financial statements and the provisions
of IFRS 1, First-time adoption of International Financial Reporting Standards,
have been applied. The interim financial statements do not include all of the
information required for full annual financial statements.
Shareholders are referred to the accompanying announcement regarding details of
the financial restatement impact as a consequence of the IFRS adoption.
DIVIDEND POLICY AND CAPITAL
The directors have recommended that no dividend be paid on ordinary shares. 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 R91,2 million (2004: R65 million) and were covered 12,5 times (2004:
14,9 times).
DIRECTORATE
Dr TV Maphai and Mrs S Sebotsa were appointed as non-executive directors to the
board of Discovery with effect from 8 December 2005.
www.discovery.co.za
EMBEDDED VALUE STATEMENT
for the six months ended 31 December 2005
The embedded value of Discovery at 31 December 2005 is calculated as the sum of
the following components:
- the excess assets over liabilities at the valuation date; and
- the value of in-force business at the valuation date (less an allowance for
the cost of capital).
The value of in-force business is calculated as the value of projected future
after-tax profits of the business in force at the valuation date, discounted at
the risk discount rate.
In the past, Life has based their embedded value on the Financial Soundness
Valuation Method (FSV). A change in actuarial guidance note (PGN107) effective
for interim reporting dates after 31 December 2005 now requires Life Insurers to
base the embedded value on the Statutory Valuation Method (SVM). The key
difference between the two bases for Discovery Life is that the negative
reserves calculated on the FSV basis are zeroised under the Statutory Valuation
Method. Discovery has adopted this new guidance note for the interim results
presented here. The net asset value has been adjusted to reflect the zeroisation
of the Life negative reserve in the statutory accounts. The net asset value is
thus reduced compared to the amount shown on the balance sheet. This has
resulted in a significant decrease in the capital adequacy requirement
underlying the calculation of the cost of capital. The value capitalised in the
negative reserve on the Financial Soundness Valuation basis is released in the
value of in-force of the Statutory Valuation Method over time.
The value of in-force and the value of new business at 31 December 2005 are
shown on both the SVM and the FSV bases to allow comparison to prior periods.
For PruHealth, no value has been placed on the current in-force business.
The value of new business is determined at the point of sale as the projected
future after-tax profits of the new business written by Discovery, discounted at
the risk discount rate, less an allowance for the cost of capital.
PricewaterhouseCoopers Inc. has reviewed the methodology and assumptions used to
determine the value of in-force business and the value of new business and have
confirmed that, overall, they are reasonable.
TABLE 1: GROUP EMBEDDED VALUE
Twelve
Six months to months to
31 December 31 December 30 June
2005 2005 31 December % 2005
R million SVM basis FSV basis 2004 change
Shareholders"
funds 3 692 3 692 2 840(1) 30 3 290(1)
Minority
Interest - - (67) (67)
Negative
reserve
zeroised (1 877) - - -
Shareholders"
funds excluding
negative
reserves 1 815 3 692 2 773 3 223
Value of in-
force business
before cost
of capital 8 466 7 028 5 604 6 483
Cost of
capital (201) (675) (434) (533)
Discovery
Holdings
embedded
value 10 080 10 045 7 943 27 9 173
Number of
shares
(millions) 529,1 529,1 520,1 528,2
Embedded value
per share R19,05 R18,98 R15,27 25 R17,37
Diluted number
of shares
(millions) 553,2 553,2 553,2 553,2
Diluted
embedded value
per share(2) R18,56 R18,49 R14,62 27 R16,93
(1) The shareholders" funds balance has been adjusted following the adoption of
IFRS.
(2) 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 outstanding shares
relating to the redemption value of the Discovery Life preference shares, as
well as 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 Value
before after
cost of Cost of cost of
R million capital capital capital
at 31 December 2005 - SVM basis
Health and Vitality 3 953 - 3 953
Life(1) 4 334 (183) 4 151
Destiny Health(2) 179 (18) 161
Total 8 466 (201) 8 265
at 31 December 2005 - FSV basis
Health and Vitality 3 953 - 3 953
Life(1) 2 896 (657) 2 239
Destiny Health(2) 179 (18) 161
Total 7 028 (675) 6 353
at 30 June 2005
Health and Vitality 3 844 - 3 844
Life(1) 2 349 (517) 1 832
Destiny Health(2) 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 of R92 million. On the FSV basis, the Life cost of capital is based
on a capital adequacy requirement of R1 881 million (December 2004: R883 million
on the FSV basis; R65 million on the SVM basis).
(2) Figures for Destiny Health reflect Discovery"s 97,92% shareholding in
Destiny Health at 31 December 2005.
TABLE 3: GROUP EMBEDDED VALUE EARNINGS
Twelve
Six months Six months months
to to to
31 December 31 December 30 June
R million 2005 2004 2005
Embedded value at end of period 10 080 7 943 9 173
Embedded value at beginning of
period 9 173 6 832 6 832
Increase in embedded value 907 1 111 2 341
Net issue of capital (10) (17) (60)
Dividends paid to Destiny Health
preference shareholders - 1 1
Transfer to/(from) hedging
reserve 3 (6) (9)
Embedded value earnings 900 1 089 2 273
Annualised return on embedded
value (%) 20,6 34,4 33,3
TABLE 4: COMPONENTS OF GROUP EMBEDDED VALUE EARNINGS
Twelve
Six months Six months months
to to to
31 December 31 December % 30 June
R million 2005 2004 change 2005
Total profit from new
business (at point
of sale) 379 375 1 783
Profit from existing
business
* Expected return 342 286 602
* Change in methodology
and assumptions(1) (35) 315 307
* Experience
variances 71 56 363
Acquisition costs(2) (58) (60) -
PruHealth start-up
costs (56) (64) (120)
Adjustment for
minority interest
in Destiny Health 3 1 4
Adjustment for
Guardian profit share
in Destiny Health(3) (8) (9) (28)
Foreign exchange rate
movements (18) (38) 43
Interest on loan
capital - (20) (50)
IFRSadjustment - (4) (8)
Return on
shareholders"
funds(4) 280 251 377
Embedded value
earnings 900 1 089 2 273
(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).
(2) A large proportion of Health and Vitality new business was written over the
period but only activated on 1 January 2006. Acquisition costs of R45 million
(December 2004: R37 million) arise in respect of these members who are not
included in the embedded value calculation. Similarly acquisition costs of R13
million (December 2004: R15 million) arise for Destiny Health.
(3) In terms of the agreement between Destiny Health and the Guardian Life
Insurance Company of America, Guardian will share in 50% of the profits from
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. Based on Guardian"s progress towards achieving
this target, the value attributed to Destiny Health"s non-alliance business has
been reduced by 33,1% (June 2005: 26,3%) in the embedded value calculation.
(4) Return on shareholders" funds is shown net of tax and management charges and
includes the return on assets under insurance contracts.
TABLE 5: METHODOLOGY AND ASSUMPTION CHANGES
for the six months ended 31 December 2005
Health and Vitality Destiny Health
Net Value of Net Value of
R million worth in-force worth in-force
Modelling changes(1) - - - 20
Lapses - - - (44)
Economic assumptions - 71 - -
Contribution increases - - - 51
Administration fees(2) - (74) - -
Expenses(3) - (71) - (82)
Mortalilty and
morbidity - - - (51)
Vitality benefits(4) - 74 - -
Tax(5) - - - -
Other - - - (1)
Total - 0 - (107)
TABLE 5: METHODOLOGY AND ASSUMPTION CHANGES
for the six months ended 31 December 2005
Life
Net Value of
R million worth in-force Total
Modelling changes(1) (1 559) 1 603 64
Lapses (33) (28) (105)
Economic assumptions (1) 113 183
Contribution increases - - 51
Administration fees(2) - - (74)
Expenses(3) - - (153)
Mortalilty and morbidity - - (51)
Vitality benefits(4) - - 74
Tax(5) - (23) (23)
Other 0 0 (1)
Total (1 593) 1 665 (35)
(1) The Life modelling change includes a R1555 million decrease in the net worth
and a R1604 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 R1,604 million increase in the value
of in-force includes a reduction of R404 million in the Cost of Capital.
(2) The Health administration fee change relates to an expected below CPIX
increase in Discovery Health Medical Scheme administration fees for 2007.
(3) The Health, Vitality and Destiny Health renewal expense assumption change is
based on the results of the most recent expense analysis (31 December 2005).
(4) The Health and Vitality assumption change includes an allowance for a
reduction in the expected benefit cost on Vitality in line with recent
experience.
(5) The tax variance reflects the movements in the value of the tax deferral.
TABLE 6: EXPERIENCE VARIANCES FOR THE SIX MONTHS ENDED 31 DECEMBER 2005
Health and Vitality Destiny Health
Net Value of Net Value
R million worth in-force worth in-force
Renewal expenses (8) - (16) -
Other expenses(1) - - (2) -
Inflation(2) - (72) - -
Extended modelling
term(3) - 94 - 13
Lapses(4) 4 82 3 (45)
Policy alterations(5) - 4 - 3
Mortality and
morbidity - - (67) -
Premium variance - - - -
Commission(6) - - - -
Other 5 14 0 (9)
Total 1 122 (82) (38)
TABLE 6: EXPERIENCE VARIANCES FOR THE SIX MONTHS ENDED 31 DECEMBER 2005
Life
Net Value of
R million worth in-force Total
Renewal expenses 3 - (21)
Other expenses(1) (10) - (12)
Inflation(2) (3) 9 (66)
Extended modelling term(3) - 3 110
Lapses(4) (20) 2 26
Policy alterations(5) 55 16 78
Mortality and morbidity 50 2 (15)
Premium variance (16) - (16)
Commission(6) (8) - (8)
Other (8) (7) (5)
Total 43 25 71
(1) For Destiny Health, other expenses are in respect of Texas office set-up and
relocation costs. For Life, the non-recurring expenses relate to costs incurred
as a result of the proposed venture with Prudential in the UK.
(2) The negative variance for Health and Vitality is due to a lower 2006
increase in the Health administration fees compared with that assumed in June
2005.
(3) The projection term for Health, Vitality, Destiny Health and Group Life at
31 December 2005 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 six months.
(4) Included in the Health and Vitality lapse experience variance is an amount
of R158 million in respect of members joining existing employer groups during
the period, offset by an amount of R114 million in respect of members leaving
existing employer groups. A positive variance of R42 million is due to lower
than expected lapses.
(5) The Life policy alterations include the positive effect of existing policies
adding the Discovery Retirement Optimiser.
(6) The commission variance includes a provision for bad debts on commission
clawbacks.
TABLE 7: EMBEDDED VALUE OF NEW BUSINESS
Six months to Twelve
31 December 31 December 31 December months to
2005 2005 % 2004 30 June
R million SVM basis FSV basis change 2005
Health and
Vitality
Gross profit
from new
business at
point of sale 60 60 67 229
Cost of
capital - - - -
Net profit from
new business
at point of
sale 60 60 67 (10) 229
New business
annualised
premium
income(1) 369 369 424 (13) 1 734
Life
Gross profit
from new
business at
point of sale 332 414 369 676
Cost of
capital (27) (98) (78) (157)
Net profit from
new business at
point of sale 305 316 291 5 519
New business
annualised
premium
income(2) 276 276 245 13 470
Annualised
profit
margin(3)(%) 13,3 13,6 14,3 13,5
Destiny Health
Gross profit
from new
business at
point of
sale 15 15 17 36
Cost of
capital(4) (1) (1) (0) (1)
Net profit from
new business
at point of
sale(5) 14 14 17 (18) 35
New business
annualised
premium
income(1) 246 246 250 (2) 603
New business
annualised
premium income
(US$ million) 38 38 41 (7) 97
(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 31 December 2005.
The total Health and Vitality new business annualised premium income written
over the period was R1 262 million (December 2004: R1 211 million). For Destiny
Health, the total new business annualised premium income written over the period
was R383 million (December 2004: R411 million).
(2) Life new business annualised premium income of R276 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 R49 million and
servicing increases of R67 million was R392 million. Single premium business is
included at 10% of the value of the single premium.
(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 six-month period. Actual new business expenses
include infrastructure development costs related to developing new business
capacity. No allowance has been made for acquisition cost efficiencies which are
expected to occur in the future.
TABLE 8: EMBEDDED VALUE ASSUMPTIONS
31 December 31 December 30 June
% 2005 2004 2005
Risk discount rate
- Health and Vitality 10,25 11,00 11,00
- Life 10,25 11,00 11,00
- Destiny Health 10,00 10,00 10,00
Medial inflation
South Africa 6,75 7,00 7,00
United States Current Current Current
levels levels levels
reducing to reducing to reducing to
12,50% over 12,50% over 12,50% over
the projection the projection the projection
period period period
Expense inflation
South Africa 3,75 4,00 4,00
United States 3,00 3,00 3,00
Pre-tax investment return
South Africa - Cash 5,75 6,50 6,50
- Bonds 7,25 8,00 8,00
- Equity 9,25 10,00 10,00
United States - Bonds 3,00 2,00 3,00
Rand/US$ exchange rate 6,3370 5,6250 6,6755
Income tax rate
- South Africa 29,00 30,00 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.
Renewal expense assumptions were based on the results of the latest expense and
budget information.
The Health lapse assumptions were based on the results of recent experience
investigations. Renewal expense assumptions were based on the results of the
latest expense investigation.
The Destiny Health morbidity and lapse assumptions were based on the results of
recent experience investigations as well as future expectations regarding
premium increases. Renewal expense assumptions were based on the results of the
latest expense investigation.
The investment return assumption was determined with reference to the cashflow-
weighted average 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. It is assumed that no tax will be
payable on interest earned in the Life Fund over the projection period.
It was assumed that the capital adequacy requirements in future years will be
backed by surplus assets consisting of 70% equities and 30% fixed-interest
securities for the purposes of calculating the cost of capital at risk.
Allowance has been made for tax and investment expenses in the calculation of
the cost of capital.
The current policy of Discovery is not to declare dividends and therefore no
allowance has been made in the embedded value calculation for secondary tax on
companies (STC). The effect of allowing for STC of 12,5%, and assuming a 20%
dividend payout ratio, is to reduce the embedded value at 31 December 2005 by
1,8% from R10 080 million to R9 894 million on the SVM basis and by 1,6% from
R10 045 million to R9 880 million on the FSV basis.
Date: 23/02/2006 09:15:27 AM Supplied by www.sharenet.co.za
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