Commentary

Introduction

Discovery Holdings posted pleasing results during the period under review, with strong financial performance, healthy new business growth and important structural progress for all Discovery’s businesses. The business environment during this period remained complex and volatile, with the economy continuing to experience the recessionary effects of the global economic crisis. Added to this, the economic crisis has also caused significant shifts in health policy debates and financial regulation internationally as governments face dramatic budget deficit increases. In South Africa specifically, this resulted in important healthcare regulatory debates around a National Health Insurance system. To meet the challenges posed by the current macro-economic and operating environment, and to achieve our long-term objectives, Discovery focused strongly on the following strategies:

1. Ensuring that the business models and structures within each business create a sustainable competitive advantage to uniquely meet clients’ needs. In particular, Discovery focused on restructuring PruHealth and PruProtect to more effectively replicate Discovery’s integrated business model
2. The pursuit of a number of new opportunities, most notably the pending acquisition of a minority stake in Ping An Health, the health insurance subsidiary of China’s second-largest insurer, Ping An Group
3. A continued and intensive focus on innovation and product excellence to ensure that products across the group are competitive, unique and provide exceptional value for money. This is particularly important during the difficult economic climate
4. A focus on financial prudence to ensure risks are carefully managed to significantly enhance the Group’s financial strength.

The result of these strategies is a strong financial performance, with headline earnings increasing by 54% to R755 million, and operating profit increasing by 49% in the comparative 2008 period. The Group embedded value increased by 4% from June 2009, to R20.9 billion. The main contributors to the embedded value growth were good profits from new business, the expected return on existing business, positive experience variances and strong investment performance. These positive impacts were to a degree offset by strengthening of the assumption set. The Group embedded value does not allow for the Health new business joining on 1 January 2010. Allowing for this new business would have increased the Group embedded value by a further 2% to R21.3 billion.

Discovery Health

Discovery Health’s performance was excellent and exceeded expectation. During the period under review, we focused on strengthening the operational, clinical and actuarial assets and capabilities of Discovery Health. At the same time, Discovery Health continues to build a robust healthcare system, while providing affordable access to high quality healthcare for our members. Discovery Health’s strong performance, when viewed against the challenges the industry faces, clearly illustrates that in the healthcare market, scale and technological sophistication are fundamental attributes for success. To further strengthen Discovery Health’s performance, we focused on three specific areas during the period under review:

1. Ensuring members’ benefits provided as comprehensive coverage as possible. We specifically focused on closing gaps in coverage, for example, the launch of the Medical Savings Booster enables members to use discounts on HealthyFood™ spend to close gaps in cover.
2. Continued and intense focus on achieving closer ties with doctors, hospitals and other healthcare providers. By the end of the period, 80% of members’ consultations with GPs and 85% of visits with specialists took place in the Discovery Health GP Network or specialist payment arrangements, resulting in less out-ofpocket costs for members. In terms of hospitalisation, the continued enhancement of the KeyCare and Delta hospital networks and the benefit plans around them, created enhanced efficiency and affordability for members.
3. Increased investment in operational, risk and managed care capabilities resulted in the development of further healthcare assets for the Discovery Health Medical Scheme. The successful launch of ProPBM, Discovery’s inhouse pharmacy benefit management system, ensured that all Discovery Health pharmacy claims were managed through this system, with significant savings to the Discovery Health Medical Scheme.

The combination of these strategies translated into excellent results for both Discovery Health and the Discovery Health Medical Scheme. The Discovery Health Medical Scheme’s contribution increase for 2010, one of the lowest in the industry, was in line with the industry benchmark set by the Council for Medical Schemes. The Scheme also has one of the largest capital funds in South Africa with reserves of R6 billion, exceeding the 25% statutory requirement. New business levels accelerated dramatically during the period, with total new business production the highest in Discovery Health’s history. In addition, Discovery Health’s ability to retain members – the Scheme’s record-low level lapse rate of 3.1% – illustrates our competitive ability. Despite the real affordability challenge for members, 98% of members maintained or enhanced their benefit choices for 2010 with only 2% opting to buy down their benefit choice. KeyCare, Discovery Health’s product for the lowerincome market, also performed exceptionally well: during our year-end process for January 2010, more than 22 000 members joined the KeyCare Plan and we estimate that almost 15 000 of these members were not previously covered by medical schemes. KeyCare’s performance continues to demonstrate Discovery Health’s ability to grow the market and to extend the reach of private healthcare into the lower-income market.

In terms of the broader South African healthcare environment, the debate around healthcare policy and the implementation of a National Health Insurance system continued. Discovery Health remains firmly committed to assisting the healthcare reform process towards building a healthcare system that is more inclusive and equitable for all South Africans. To this end, we have been actively providing input into the debate. We have also been focusing on areas where we can work with the Department of Health to build capacity in the public healthcare system to help meet the Millennium Development Goals to which South Africa has committed itself. The Discovery Foundation, one of our capacity-building initiatives in the healthcare sector, has entered its fourth year and has to date, awarded R37 million in grants to 63 recipients for further medical research and training.

Over the course of 2010, Discovery Health will look to leverage our sophisticated risk management, clinical and provider assets in the closed schemes environment. Discovery Health’s current 8% market share in this segment represents a significant growth opportunity given the breadth and competitiveness of our managed care and wellness capability. We are pleased with our early progress, with the activation of two new closed schemes, Remedi and Altron, over the first half of 2010. This brings to 14 the number of closed schemes that Discovery Health administers.

Discovery Life

The performance of Discovery Life was pleasing despite the current difficult economic environment. Independent surveys and industry recognition illustrate the company’s strong and dominant position in the life assurance protection market. The company has enhanced its competitive position in the market with a 24% market-share of all broker business, and a 26% market share in the large policies market, which is Discovery Life’s core focus. While overall new business decreased by 2%, this largely reflected the reduction in inflation resulting in a decrease in the automatic increase component of new business. However, the core individual risk new business grew by 16%.

During the period under review, Discovery Life worked on the following strategies:

1. Continued focus on ensuring the business model is capital efficient and cash flow generative. This was achieved by largely removing the lapse risk from emerging negative reserve assets generated by the sale of new business, and using these to back guaranteed capital bonds, sold through Discovery Invest. The result is significantly enhanced liquidity with reduced negative reserve risk. Discovery Life covered its Capital Adequacy Requirement more than 8.6 times.
2. The understanding and management of policy lapses are particularly important during the difficult economic climate, with lapse rates falling within the assumptions laid out in the embedded value. While Discovery Life took a conservative view of lapse rates going forward and further strengthened the embedded value basis, during the period under review, lapse rates stabilised and began to drift downwards.
3. A continued focus on relevant and appropriate product innovation and excellence. During the period under review, we launched the Financial Integrator™ series – a range of products aimed at providing policyholders with life assurance protection that flexes according to economic conditions. This unique product range dynamically protects policyholders during a life-changing event or should they retire during weak economic conditions when assets are depressed. Despite this product only being launched towards the end of 2009, by early 2010, 25% of all new business written included the Financial Integrator™.
4. Enhancing and growing the company’s distribution capability with the continued roll-out of an agency force of the highest quality and top-producing agents. By December 2009, we employed over 250 agents, generating an average monthly production of around R110 000 per agent. The contribution of the agency force to new business has increased steadily over the past year, with 20% of total Discovery Life and Discovery Invest new business currently being generated by the agency channel.

Discovery Invest

Over the period, Discovery Invest’s performance was exceptional in all respects, despite the difficulties introduced to long-term savings businesses by the economic climate. New business API grew by 74% over the comparative period while maintaining margins. Intermediary support improved substantially from the levels seen at the start of the year, and performance from the company’s broad range of funds was excellent, with the flagship Equity Fund consistently ranked as a top performer. Discovery Invest is currently attracting approximately 8% of net industry inflows in the retail linked-product market, equivalent to those of established players such as ABSA and Investec. By 31 December 2009, Discovery Invest had grown its assets under management to more than R6.5 billion. Importantly, the majority of assets continue to be invested in Discovery Invest’s higher-margin, proprietary funds.

During the period, we continued to develop our assets and capabilities, with a specific emphasis on enhancing our distribution footprint and penetration. Over 2009, the company’s products gained increasing recognition and support in the intermediary market, with average broker support levels increasing from around a 1 000 a month at the start of the year, to almost 3 000 every month. In addition, Discovery Invest is in the process of developing a Specialist Franchise that will target large investment brokers who are not yet supporters of Discovery Invest. This initiative is currently in the early stages of development, and will continue to be rolled out over 2010.

During the period, Discovery Invest focused on:

1. The launch of Discovery Invest Offshore, which enables clients to access a broad range of best-of-breed international fund managers and apply Discovery’s proprietary product design to these
2. Using Discovery’s integration capability to develop products that are highly differentiated and offer added value. One of the initiatives launched during the period, the InvestBooster™, leverages the Vitality HealthyFood™ structure to allow members to channel discounts on their HealthyFood™ spend into their investment vehicles.

Financially, Discovery Invest made significant progress towards reaching a break-even position, with a 75% reduction in losses over the comparative period in 2008. We remain confident that the business is well positioned for continued growth in assets in the coming period.

Discovery Vitality

Discovery Vitality serves as the primary point of integration across each of Discovery’s businesses and facilitates the development of differentiated products with unique appeal. Early in 2009, Vitality launched the Vitality HealthyFood™ benefit in conjunction with Pick n Pay and during the second half of 2009 successfully rolled out the benefit.

Since the launch of the benefit, over 180 000 members have activated the Vitality HealthyFood™ benefit, buying over three million trolleys of HealthyFood™ valued at over R275 million.

Given the success of the HealthyFood™ benefit, we see significant opportunity to leverage the benefit in product development initiatives. During the 2010 development cycle, a number of key initiatives were launched with HealthyFood™ at their core; as discussed in the Discovery Health and Discovery Invest sections earlier, the Medical Savings Booster and InvestBooster™ allow members to forego the cash backs on HealthyFood™ spend for more significant health or investment benefits. Discovery will continue to leverage the appeal of the benefit in future product design.

The HealthyFood™ benefit has further been instrumental in elevating the profile of the DiscoveryCard, with almost 40% of HealthyFood™ activations being made through the DiscoveryCard. In December 2009, card turnover exceeded R1 billion for the first time, thereby strengthening the DiscoveryCard’s strong gain in pointof- sale market share at the expense of the current banking institutions. Over the year, DiscoveryCard gained almost 1.5% market share, and now holds 7% of the total credit card market. DiscoveryCard’s credit performance has also been exceptional, with our current experience better than both competitor experience and credit cycle averages.

Going forward, Vitality is investigating how best to evolve the credibility of its science and broad-based appeal into a social development context. In this regard, Discovery has successfully launched an employee Corporate Social Investment initiative – the Vitality Healthy Giving campaign – that links employees’ Vitality engagement to donations to charities. During 2009, almost R1 million was raised for charity through this initiative.

PruProtect and PruHealth

The period under review was a particularly significant one for Discovery’s joint venture with The Prudential in the UK. The joint venture represents a considerable initiative and opportunity for Discovery and, in this context, important work was done with both PruHealth and PruProtect to facilitate this. PruProtect made considerable strides during this period and the company’s performance exceeded expectation. New business grew by 245% to R100 million, while operating losses reduced by 58%. Notably, the quality of new business exceeded expectation with average premiums and the take-up of additional benefits higher than expected. While still too early to gauge, lapse rates and claims levels are better than expected. In addition, both the franchise and telephone account management distribution channels grew extensively and gained considerable traction.

PruHealth’s performance reflected the negative effects of the economy and the impact of negative business mix changes, which saw a drop in the proportion of individual members. In addition to the expected increased claims levels during recessionary periods, the mix change further increased the loss ratio, as the individual members were on average lower claimants. The combination of these created an increased loss ratio during the period under review, negatively impacting the financial performance. Despite the immediate negative impact, the loss ratio has begun to decrease, as expected. PruHealth has, however, made good progress with lives covered growing by 15% to 219 000 and operating losses reducing by 13% to R53 million.

Most importantly, the period under review reflected the significant strategy of restructuring both PruHealth and PruProtect to create an integrated business model that more effectively replicates the Discovery model in South Africa. We anticipate that this will create greater expense efficiencies and better profit margins that will enable more competitive product offerings. Importantly, it will enable the joint venture to offer unique and powerful integrated protection products to the UK market. In addition, the strong distribution channels that already exist within PruHealth, combined with the rapidly emerging franchise distribution channel of PruProtect, will provide the joint venture with considerable reach for both products.

Prospects

The progress made and work done in all of Discovery’s businesses, positions the Group well for further growth.

MI Hilkowitz	A Gore
Chairperson	Chief Executive Officer