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Commentary

Introduction

Discovery posted strong results for the six-month period to 31 December 2010. While the period under review was complex, impacted by both the financial crisis and the considerable policy debates that affect the markets in which Discovery operates, the performance across Discovery’s businesses was pleasing. Notably, during this period, the South African economy started to stabilise and consumer confidence increased. Discovery is strongly of the view that South Africa has made considerable progress on a number of important fronts and remains excited and optimistic about the country’s future. Discovery continues to be focused on playing a positive leadership role in South Africa.

Over the last 12 months, and particularly during the six-month period under review, Discovery focused on achieving growth in three key strategic areas:

  1. In Discovery’s South African businesses, quality, growth and innovation were the important areas of focus. In the context of Discovery Health, this enabled us to balance the natural tension that exists between offering access to best quality care and affordable premiums, and ensuring sustainable growth. For Discovery Life, this manifested in a significant reduction in lapse rates and superior mortality and morbidity experience. Vitality experienced significant increases in levels of engagement, thereby further entrenching Vitality’s role as a differentiator through its integration capability and ability to improve mortality and morbidity experience. Discovery Invest continued to strengthen its position in the retail investment space with new product designs and platforms.
  2. In Discovery’s international businesses, a step-change in strategy was employed to achieve scale, profitability and relevance – with a focus on leveraging Discovery’s unique intellectual property and capabilities to organically build businesses with minimal exposure to capital downside. In particular, the acquisition of Standard Life Healthcare, the significant work done within PruHealth and the continued successful roll-out of PruProtect, have created a business of significant size and potential in the United Kingdom. Furthermore, the important transaction concluded with Humana Inc. (Humana) in the United States and the acquisition of 20% of Ping An Health in China, provide considerable upside potential without significant capital risk.
  3. A continued focus on building new businesses based on the unique business model of Discovery in the South African market.

The results of these strategies were pleasing:

Discovery Health

Discovery Health’s performance exceeded expectation. Despite the previous period’s high base, new business grew strongly by 10% and operating profits increased by 12% from R555 million to R619 million. The total medical scheme membership managed by Discovery Health increased by 12% to 2.5 million lives.

Discovery Health operates in a unique and complex environment in which clinical, actuarial, technological and regulatory factors coalesce. It is Discovery Health’s role to navigate these complexities and ensure access to quality healthcare on a sustainable basis. To achieve this during the period under review, continued focus was applied by Discovery Health to developing benefit plans, provider networks, healthcare management capabilities, and technological platforms that improve the journey of its medical scheme members under management in the healthcare system. The results were positive: the Discovery Health Medical Scheme, the largest open medical scheme in South Africa, posted the lowest contribution rate increase among major medical schemes and grew membership by 10%; lapses reduced to the lowest levels yet experienced; and importantly, almost 98% of members maintained or increased their benefit choices with only 2% buying down benefits in 2011.

A fundamental goal of Discovery Health is to improve access to private healthcare for the low-income sector of the population and the progress made was excellent. Membership of the Discovery Health Medical Scheme’s plan series for this market, KeyCare, grew by 34% to 340 000. As at December 2010, the scale of KeyCare was equivalent to the third largest medical scheme in the country. During the period, Discovery Health also achieved considerable success with products designed to close gaps in healthcare coverage. For example, significant take-up was achieved by the Medical Savings Booster, which enables members to channel discounts on HealthyFood™ purchases at Pick n Pay towards funding gaps in cover. In addition, a number of important innovations were rolled out that are aimed at reducing the cost of care and member out-of-pocket exposure and improving both the quality of care and the member’s experience in the healthcare system. To facilitate this, significant investment was made in Discovery Health’s technology platforms and risk management assets, such as electronic patient records and the development of a coordinated care model to manage complex cases. Discovery MedXpress is also being rolled out so that medical scheme members can enjoy the benefit of direct, same-day delivery of medicine, while enabling Discovery Health to manage formularies and quality of compliance. The combination of these initiatives enables Discovery Health to offer members lower price points per unit of benefit chosen.

Discovery Health is determined to improve the quality of the South African healthcare system for all South Africans. In this regard, Discovery Health is committed to contribute to the successful implementation of a National Health Insurance system for South Africa, while also ensuring the sustainability and strength of the private healthcare sector as an integral part of the overall national healthcare system.

Discovery Life

Discovery Life’s performance was pleasing, with operating profit growing by 14% from R675 million to R768 million, new business increasing by 6% from R782 million to R832 million and the value of in-force business increasing by 14% from R8.4 billion to R9.6 billion. Notably, the positive non-economic experience variances in the embedded value illustrate the quality of the business being transacted and how it is being managed. As stated, considerable focus was applied to the quality of the business, specifically new business, lapse rates, mortality and morbidity experience, as well as capital utilisation and return on capital:

  1. In the context of new business, exposure to categories that have historically generated high levels of lapses was reduced, such as the curbing of internal replacements and the re-pricing of business assurance. The effect of this was to increase the quality of new business but moderate its growth. Notably, adjusting for the impact of these categories resulted in new business growth on a like-for-like basis of 16%.
  2. Discovery Life recorded a significant reduction in policy lapses to below the embedded value assumptions set for 2011. This has been an important strategy given the industry’s escalated levels of lapses during the economic slow-down. The strategies employed have illustrated the importance of Discovery’s integrated model and the benefits of policyholders’ engagement in Vitality, with significantly lower levels of lapses being observed for engaged policyholders compared to policyholders who are not engaged.
  3. The mortality and morbidity levels were better than expected, illustrating the quality of the business model. Importantly, the benefits of Discovery’s integrated product strategy appear to be having a positive effect on selective lapsation – the mortality and morbidity experience has been improving with policy duration and is an important factor in the sustainability and profitability of the business going forward.
  4. Continued focus was applied to the company’s business model to ensure capital efficiency. As stated at the previous announcement, a unique model utilising Discovery Life’s negative Rand reserve as an asset to back capital bonds sold by Discovery Invest, has proved to be particularly successful. In addition to this, other areas of capital efficiency were achieved. Going forward, it is expected that the company’s capital requirements will be reduced by R3 billion. The combination of these initiatives will be to increase the return on capital of the business by 3% to 5%.

Discovery Invest

Discovery Invest’s performance exceeded expectation in all respects, with strong new business growth and mix as well as fund performance driving profitability. New business increased from R334 million to R397 million and for the period under review, operating profit of R44 million was generated compared to the operating loss of R24 million during the comparative period. Discovery Invest’s strategy has been to focus on the retail long-term savings market and to provide unique added value to consumers investing in an open architecture environment that offers investors considerable choice and investment performance. During the period under review, this strategy was maintained through, for example, the development of the Guaranteed Escalator Annuity and the Classic Flexible Investment Plan – both product constructs aimed at providing unique types and levels of protection to customers:

These products provide enhanced exposure to the two biggest retail market segments for Discovery Invest.

The excellent investment performance achieved by the Discovery Invest funds was also noteworthy, with the Discovery Equity Fund and the Discovery Flexible Property Fund ranking top of their sectors since inception, and Discovery Invest’s Property Fund winning the Raging Bull Award. The combination of these factors drove growth in assets under management, with 87% of fund choices allocated to Discovery Funds, an important factor in driving profit margins. It is anticipated that Discovery Invest will continue to grow in scale, quality and profitability.

Vitality

Vitality’s performance was exceptional and its role in product integration, engagement and achieving superior levels of mortality and morbidity experience accelerated during the period under review. Engagement levels of key Vitality benefits increased dramatically with gym membership rising by 20% from 296 116 to 356 533; HealthyFood™ activations exceeding 228 000; and levels of engagement across all Vitality categories increasing. Vitality has continued its work in understanding the link between engagement with Vitality and mortality and morbidity experience from an academic perspective, and the link between different incentive types and the effect of complex and simple behaviours to establish positive health behaviour. It is this significant knowledge and capability that has been used to underpin both Discovery’s local and international businesses.

The DiscoveryCard performed particularly well during the period under review and reflected both the quality of Discovery’s client base and the improving economic environment. The DiscoveryCard captured 8% of the point-of-sale market share and the quality of the credit experience remained above expectation. Today, Discovery members spend almost R1 billion per month on their DiscoveryCards. An exciting advancement during the period was the development of the Discovery Purple Card aimed at providing the higher-end market segment with unique value.

PruHealth

A change in strategy to achieve scale, relevance and profitability for PruHealth, delivered positive results during the period under review. Firstly, the acquisition of Standard Life Healthcare accelerated Discovery’s strategy in the United Kingdom, with the transaction providing immediate scale in the Private Medical Insurance market, as well as the opportunity for Discovery to increase its shareholding in both PruHealth and PruProtect, from 50% to 75%. As part of the Standard Life Healthcare acquisition, Discovery secured long-term access to Prudential plc’s brand and life fund in the United Kingdom, which is important to the competitive position of both PruHealth and PruProtect. Secondly, considerable work was undertaken to manage the key value drivers of the PruHealth standalone business, with activity intensifying over the past six months. The combination of these initiatives resulted in an operating profit of R35 million (100% of income), versus a loss of R53 million (50% of loss) during the comparative period. New business increased by 90% from R165 million to R313 million, and removing the effects of the Standard Life Healthcare new business, PruHealth’s new business increased by 35%. Importantly, PruHealth’s combined Vitality and claims loss ratio reduced by 15%, while expense per policy reduced by 27% on a calendar year basis and positive lapses and selection were achieved during the period.

During the period under review, delivery was taken of the Standard Life Healthcare business and the process of integrating it into the PruHealth business began. The quality of the asset acquired surpassed expectations, with the loss ratio, levels of lapsation and profitability levels exceeding expectation. The combination of the management action undertaken within PruHealth, and the acquisition of Standard Life Healthcare, has created a business with strong fundamental drivers of value and one that represents significant prospects for Discovery.

Considerable research and development was also undertaken to develop a unified product range that reflects the unique strengths of both businesses. This product range was launched during February 2011 and incorporated the modularity of Standard Life Healthcare’s previous product range with the Vitality integration capability of PruHealth. PruHealth remains confident in its ability to transact increased levels of profitable new business via the new product range.

PruProtect

PruProtect delivered an excellent operating performance with strong growth in both new business and earnings, and industry recognition of its differentiated product offerings. New business grew by 44% from R100 million to R144 million and operating losses narrowed to R40 million (100%).

PruProtect’s strategy is to build a significant life insurance company on a similar basis to that of the Discovery Life model to provide unique value to customers in the United Kingdom. Given the complexity of the market and its capital intensity, it is imperative that the business is built on the basis of quality. In this regard, PruProtect exceeded expectations: lapses were lower than expected, mortality and morbidity experience were better than expected, and the product mix was acceptable. Additionally, given the business’s increasing scale, expenses per policy decreased by 57%.

The offsetting of negative reserves created by PruProtect against positive reserves within Prudential plc’s life fund has enabled PruProtect to achieve scale on a relatively light capital basis. The combination of this and the strong underlying performance has created a business that is expected to achieve superior returns on capital.

During the period under review, PruProtect concentrated on strengthening and increasing the breadth of the Independent Financial Advisers distribution channel through PruProtect’s franchises. From a product perspective, PruProtect was once again recognised as the leading protection provider in the United Kingdom, further winning industry awards for its innovative critical illness and income protection cover. In addition, work was done on a number of different product offerings that will be rolled out during March 2011.

The Vitality Group

Over the last few years, Discovery has maintained a small presence in the United States via The Vitality Group that develops and markets Vitality to large employers and health carriers. Given the uniqueness and potential of Vitality, the importance of wellness in a post healthcare-reform environment in the United States, and Discovery’s considerable Vitality capabilities, a decision was made to accelerate The Vitality Group’s development dramatically. This included the expansion of the wellness and reward network, and refinement of the clinical and actuarial pathways supporting the programme. Despite a relatively insignificant distribution capability, The Vitality Group membership grew to 140 000 members by the end of 2010. Importantly, the structure of the business minimises Discovery’s exposure to capital and earnings risk.

To up-scale the business and capitalise on emerging opportunities, Discovery concluded a transaction with Humana, the fourth largest health insurer in the United States covering 18 million members (comprising 10.2 million medical members and 7.1 million ancillary product members). Under the terms of the transaction, Humana will capitalise a new entity, US-based Humana-Vitality, in which Discovery will hold a 25% stake. Humana-Vitality will provide Humana members with access to the Vitality programme, which will be tailored to Humana’s product range and markets. Furthermore, Humana will acquire a 25% stake in The Vitality Group.

The transaction will result in Discovery being able to leverage its unique consumer-engaged and integrated health-and-wellness model in the United States health insurance market with little capital and no insurance risk, while retaining The Vitality Group’s autonomy to pursue the self-insured employer wellness market. The greater scale and capital afforded by this structure will allow The Vitality Group and Humana-Vitality to considerably enhance the existing wellness networks and platforms in the United States.

During the period under review, work was also done to operationalise the partnership with Wellness and Prevention Inc. (a Johnson & Johnson company), in preparation for the 2011 quarter one launch.

Ping An Health

Over the past six months, significant work has taken place to operationalise Ping An Health, the joint venture between Discovery and the Ping An Group of China, the world’s second-largest insurance company. During the period under review, the necessary regulatory approvals were received from the Chinese Insurance Regulatory Commission. Operationally, the process of transferring the necessary product and system capabilities to Ping An Health began, with the Discovery team deployed successfully. From a product perspective, significant work has taken place to tailor the Discovery capabilities to the Chinese market and we remain excited by the potential of the Chinese private health insurance market in the long-term.

 

MI Hilkowitz A Gore
Chairperson Chief Executive Officer

 

 

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