Commentary
Overview
Discovery posted an excellent performance over the first six months of the financial year to 31 December 2011. The results for the period reflect a continuation of the Group’s strategy to make a profound impact on the lives of those it serves and to bring about positive societal change. A commitment to making people healthier and enhancing and protecting their lives is the underpin of this strategy. Following from this core purpose is the Discovery integrated business model of health insurance, life insurance, financial services and Vitality: this allows superior products and solutions to be offered to Discovery’s members in a way that is affordable, sustainable, and provides unique value for money. Leading from this, Discovery has developed a powerful ambition to become a multinational organisation, based on a number of important principles: a disruptive, positive force in the markets in which it operates; the ability to command substantial market share; products that are superior and that people want to buy; and an overall presence that is inspiring and transformative for society.
The cumulative effect of this model and approach has created two virtuous cycles: the first, a strong and unique set of technology, product and intellectual property capabilities that are appealing to other markets and attract best-of-breed local partners; the second, a capital-light model wherein Discovery’s significant international expansion can leverage the capital strength, brand and presence of these partners. In addition, the high dividend cover enables further reinvestment into building out existing Discovery businesses, coupled with the commitment to allocate between 5% and 7% of the organisation’s operating profit towards the development of new businesses, such as Discovery Insure. During the period under review, the Group continued to drive this strategy, with the approach validated by the ability to build businesses in different markets and geographies, with minimal capital strain and with phased implementation.
Discovery’s businesses can therefore be characterised into three distinct groupings: first, established businesses that typically exceed five years; second, developing businesses with a maturity of between three to five years; and third, new businesses with less than three years since inception. It is within this context that the results should be considered: new business increased by 21% from R3 747 million to R4 535 million, and notably, established businesses increased by 6% from R2 876 million to R3 055 million; developing businesses by 14% from R854 million to R977 million; and new businesses increased substantially from R17 million to R503 million. Similarly, operating profit increased by 22% from R1 332 million to R1 629 million, with established businesses increasing by 11% from R1 388 million to R1 544 million; developing businesses by 523% from R39 million to R243 million; and the amount spent on new businesses increasing from R95 million to R158 million.
It is also important to note that the Group generated R1.8 billion in cash and reinvested R1.1 billion into new business and distribution capabilities for Discovery Life and Discovery Invest. The organisation as a whole has generated a return on capital of 60% per annum since inception, using the market capitalisation as a measure of value, and serves a sizeable global client base of over 5.5 million unique members across its businesses.
Established businesses |
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* New business: R3.1 billion |
* Operating profit: R1.5 billion |
* Unique members: R3.0 million |
1. Discovery Health (South Africa)
Discovery Health’s performance over the period was excellent and exceeded expectation. In combination, the significant growth of the Discovery Health Medical Scheme and the other medical schemes that Discovery Health administers, together with the efficiencies achieved within Discovery Health, enabled the company to explicitly reduce the administration fees charged to the Discovery Health Medical Scheme by R100 million (including VAT) for the 2011 calendar year, whilst maintaining an increase in profits of 10%. This strategy will facilitate continued growth of reserves in the Discovery Health Medical Scheme and will support growth. The company believes that this is a well-balanced result and is a continuation of a process of achieving efficiencies of scale, and passing these on to members of the Discovery Health Medical Scheme. In fact, when considering the drivers of medical inflation over the past five years, administration expenditure is the only component of the medical scheme’s expenditure which has been reducing consistently in real terms; in this regard, while medical inflation has averaged 10,5%, administration fees have had a deflationary effect of 4% for the past five years.
In addition to the strong growth in membership, the period is also noteworthy for the continued efforts made by the Discovery Health Medical Scheme to rebalance benefit structures in order to eliminate waste as well as to increase benefits in areas of critical care such as oncology. While this process led to public debate around the restructuring of the Allied Health and Therapeutic Benefit, it is seen as necessary to redirect spend towards more appropriate coverage. This strategy results in benefits that are comparable to the best private health systems in the world, yet at the same time provides access to superior healthcare when members are sick. Discovery Health will continue with this process of rebalancing benefits as required from time to time in order to ensure ongoing stability and cover for the most critical healthcare needs.
The third prevalent theme during the period is that of building and strengthening a sustainable healthcare system. In this regard, Discovery Health used this period to invest significantly in a range of technological and service innovations aimed at improving the quality and efficiency of the healthcare system for the benefit of its members. Key innovations include the development of a South African first iPad application which provides doctors treating Discovery Health members with access to members’ full health records; MedXpress, a national medicine delivery service providing Discovery Health members with home delivery of acute and chronic medicines at no charge; and HospitalXpress, a range of services designed to facilitate rapid and efficient authorisation and admission of Discovery Health members to hospitals.
In terms of the above-stated strategy, the robustness of the private healthcare system and Discovery Health’s success within it, are strongly illustrated by the movements of members. During the period, in addition to the strong growth achieved, the number of members leaving the scheme (the lapse rate) reduced to 3.9% on a calendar year basis (including an allowance for IBNR), amongst the lowest in the Scheme’s history. Furthermore, despite the expense of private healthcare, the number of members staying with their current benefit options or buying up to higher benefit options measured 98%. The combination of these metrics reflects a remarkably sustainable system and bodes well for the continued success of Discovery Health and Discovery Health Medical Scheme.
Finally, it is important to state Discovery Health’s belief that our private healthcare system, while having room for further improvement, is excellent, sustainable and an important national asset. This may seem in stark contrast to common views of waste and inevitable decline in the private healthcare system. A rigorous analysis of the facts suggests the opposite. Access to care for those covered by medical schemes is comparable to the best healthcare systems found in developed markets: the quality and outcomes are of the same order of magnitude, while the cost, adjusting for purchasing power parity, is lower. Importantly, despite the understandable concerns about gaps in medical scheme coverage, coverage levels in reality are significantly comprehensive. Members of the Discovery Health Medical Scheme, for example, had 97% of all hospital claims paid out in the 2011 year translating into R14.1 billion from January 2011 to December 2011. It is in light of this that Discovery Health is a strong advocate of a coordinated effort to improve the entire South African healthcare system. The company remains committed to a National Health Insurance system that is a conduit of this change. In this context, a strong private sector should be seen as an asset.
Discovery Health remains confident of its ability to grow its profitability on a sustainable basis into the foreseeable future, through a combination of ongoing growth in members under management and further gains in operational efficiency.
2. Discovery Life (South Africa)
Discovery Life’s performance was excellent with new business increasing by 7%, operating profit increasing by 12% from R768 million to R862 million, and the value of in-force business increasing by 20%.
During the period under review, Discovery Life continued along a set strategy of focusing on market leadership through product innovation, and on quality of new business to ensure superior performance in terms of policy lapsation and mortality and morbidity experience. The results illustrated the success of this strategy, with lapses reducing by 1% per annum and falling below the long-term assumptions within the embedded value basis, and mortality and morbidity experience 15% below the embedded value basis. The growth in new business also reflected the market’s acceptance of the continued process of innovation. During the period, the Access Cover product and other innovations were successfully rolled out to the market.
A central aspect within Discovery Life is the dynamic pricing of policyholder premiums based on their engagement with Vitality. Policyholders who engage with Vitality experience lower premium adjustments and higher periodic payback benefits. Over the period, Discovery Life saw a continued and significant increase in engagement, leading to lower levels of premium increases, and substantially higher levels of payback benefits. The effect on the actuarial dynamics of Discovery Life is substantial in that it prices risk more accurately and reduces lapsation.
It is also important to state that Discovery Life is still in a strong growth phase and is funding the growth of Discovery Invest. Although Discovery Life generates in excess of R1.6 billion of cash per year, the cash emerging is currently reinvested into new business and the building out of distribution channels. Discovery has made an explicit decision that this is an appropriate strategy, and will continue to support it into the foreseeable future. Discovery Life provides a unique opportunity to invest considerable amounts of capital at superior rates of return – in fact, the return on capital invested since Discovery Life’s inception is in excess of 27%. Taking current claims experience into account, the return on capital since inception exceeds 30%. The return per rand of capital invested into new business comfortably exceeds target levels and is further bolstered by financing structures.
Important also is the nature of the asset being built in Discovery Life, and its value – this is primarily a function of future policyholder lapsation and levels of mortality. Discovery Life is confident of its ability to control the former and in the case of the latter, worldwide mortality levels together with the selective effect of Vitality are likely to see mortality experience improving. The combination of these will be to boost the returns on capital invested in Discovery Life. In addition, the effect of motor vehicle accidents on mortality, and Discovery’s increasing Discovery unaudited interim results and cash dividend declarations 3 understanding of how its members drive through VitalityDrive™, will provide opportunities to incentivise members toward better behaviour and further increase Discovery Life’s ability to price risk accurately and provide value for money.
3. Vitality
Vitality’s performance over the period was exceptional and it continues to serve as a critical foundation across Discovery’s businesses. Most importantly, it has a profound impact on the mortality and morbidity levels of all Discovery’s members and provides a critical pricing and behavioural basis for the sustainability of Discovery’s product offerings. The Vitality model is powerful: it creates a virtuous actuarial cycle wherein rewards are used to incentivise the appropriate behavioural change; behaviour change leads to a reduction of mortality and morbidity, thereby reducing claims costs; and the reduction in claims costs ensures that the system remains in balance, and so on. The benefits of this cycle are experienced by all stakeholders: clients, Discovery and society. It is this cycle that Discovery aims to replicate in a number of markets.
A fundamental measure of the success of Vitality are the levels of engagement and the underlying behavioural dynamics of the base. During the period, engagement levels grew off an already positive base, with gym visits increasing to more than 20 million visits for the calendar year; Kulula flights increasing from just over 500 000 flights in 2010, to over 750 000 flights for the 2011 calendar year; and South African participation in wellness activities increasing dramatically, with over 50% of the eligible population completing their Health Risk Assessments, over 50% having their glucose tested, and over 50% having their cholesterol assessed.
Furthermore, the DiscoveryCard, which on implementation was essentially a Vitality reward structure, has continued to evolve into a substantial business in its own right. During the period, the experience of the DiscoveryCard was exceptional and exceeded expectation, with the number of accounts exceeding 290 000; the level of active accounts exceeding 85%; the bad debt levels reducing further to 0.07% of advances, and point of sale market share averaging just under 9%. In this regard, the DiscoveryCard provides a powerful foundation to further development of the Discovery Group. In addition, the data emerging from the DiscoveryCard provides a powerful understanding of the correlation between consumption behaviour and other risk behaviours important to Discovery.
During the period, the rollout of VitalityDrive™ – the behavioural underpin for the Discovery Insure business – also continued. Although early in its implementation, the results are pleasing, with 98% of all Discovery Insure members opting to purchase VitalityDrive™.
Finally, virtually all aspects of the Vitality capability in terms of intellectual property, technology, online capability and actuarial models, have been structured to be easily deployed in markets outside of South Africa. Sophisticated and tailored Vitality models are being actively rolled out in the US with Humana; the UK with the PruHealth and PruProtect businesses; and will be deployed shortly in the Ping An Health joint venture in China.
Developing businesses |
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* New business: R1 billion |
* Profit: all profitable; R243 million |
* Unique members: R0.7 million |
4. Discovery Invest (South Africa)
During the period under review, Discovery Invest achieved an excellent performance with assets under management growing by 50% from R13.9 billion to R20.9 billion, and operating profit by 84% from R44 million to R81 million.
The success of Discovery Invest reflects a combination of the market’s receptivity to Discovery Invest’s strategy to offer value-add products, together with the exceptional performance of Discovery Invest’s portfolio of funds. Notably, the Discovery Equity Fund continues to perform at the top of its peer group and based on this, attracted more than double the inflows of its nearest competitor. The value-add approach of Discovery Invest has created an ability to generate superior profit margins in the products provided, while an important driver of the emerging profitability is its achievement of scale, leading to a reduction in unit costs. It is anticipated that this trend will continue given Discovery Invest’s considerable growth potential.
5. PruProtect (United Kingdom)
The period under review was a particularly successful one for Discovery’s UK businesses, with their combined profitability turning from a loss of R5 million to a profit of R162 million. Both businesses made strong progress in their respective markets and Discovery’s vision of building a Discovery-like capability in the UK now appears realistic, with great potential for scale and profitability. In particular, PruProtect’s performance was remarkable and in a short space of time since its launch, it has become a major player in the UK protection market. Importantly, while each business focused on the unique dynamics of the markets in which they operate, over the period a considerably more powerful Vitality capability was rolled out, taking into account many of the South African learnings. This bodes well for both businesses to differentiate themselves in their respective markets.
PruProtect’s performance was exceptional and significantly ahead of expectation. Virtually every aspect of the business made outstanding progress and manifested in profit growing from –R40 million to R115 million. In addition, PruProtect comfortably exceeded return on capital hurdles for new business written during the six months ending 31 December 2011.
The PruProtect strategy revolved around repeating the Discovery Life model in the UK. This has been followed closely in all aspects of the business model, from product innovations and processes, to distribution initiatives. Most importantly, PruProtect’s profitability is a manifestation of the quality achieved across key dimensions of the business: levels of mortality were lower than expected; the average premium was higher than expected; and inflation-linking exceeded expectation.
One of the most important successes was that of the franchise distribution model: while new business grew 51% from R144 million to R218 million, the franchise channel itself grew by almost 100%. The implication of this was that the make-up of new business was of a far higher quality than the previous period under review. In addition, the combination of the product and distribution capability has enabled PruProtect to be included on the panels of many of the most powerful distributors, and PruProtect expects sizeable growth from these initiatives going forward.
In just four years since its launch, the company is now capturing in excess of 8.5% of the broker-distributed life insurance market, and generating new business margins of around 16.5%. Discovery is optimistic about the prospects of PruProtect going forward.
6. PruHealth (United Kingdom)
PruHealth’s performance during the period was pleasing and in line with expectation. The period was dominated by two distinct forces: the difficult economic environment, leading to a weakened private medical insurance market in which there was adverse lapsation; and second, the integration of Standard Life Healthcare and PruHealth.
Against this, PruHealth made significant progress, with its explicit decision to focus on quality and to ensure that loss ratios were stable and robust. This was achieved by applying careful risk and actuarial processes to the management of the business. The results of this approach were satisfying, with the loss ratio in the PruHealth book and the acquired Standard Life Healthcare book drifting downward to levels better than expectation. The concomitant effect of this was that lapse rates of previously higher loss ratio groups escalated, as these were priced up; and new business reduced following the decision to price at sustainable levels. By the end of the period, all actuarial dynamics of the business were in line with expectation and the company focused on rolling out the new product range with a significantly-enhanced Vitality capability. It is anticipated that levels of new business during the next period will show improvement. With the positive foundation created, the business should generate strong profitability going forward.
In respect of integration infrastructures, considerable progress was made in terms of how the two businesses will be brought together from both a technology and product perspective. Despite the profit achieved during the period, it is anticipated that once this integration has occurred, an additional saving of approximately R80 million to R100 million will be achieved, with the full saving likely to emerge in the 2014 financial year.
New businesses |
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* New business: R0.5 billion |
* Investment: 8.8% of profit |
* Unique members: R1.8 million |
7. Discovery Insure (South Africa)
Discovery Insure was launched just prior to the reporting period under consideration and its receptivity and progress have exceeded expectation. New business since inception has exceeded R140 million API, with total inforce policies at 31 December 2011 of 7 986. The premise on which Discovery Insure is based is the extension of Discovery’s behavioural expertise into affecting the way people drive, so that they pose lower insurance risk, and more importantly – lower mortality and morbidity risk. In this way, Discovery Insure’s purpose is completely aligned with the overall Discovery purpose and the business has been created to disrupt the traditional short-term insurance models that use claims experience as a proxy for risk and reward lower risks with lower premiums. In contrast, Discovery Insure accurately measures driving behaviour to assess risk and rewards lower risks on a realtime basis with more tangible and immediate benefits that impact behaviour.
Three of the key strategic barriers that required attention was ensuring that the telematics technology could be made mainstream with relevant and accurate data available instantaneously; overcoming policyholders’ reservations that being tracked would feel intrusive in any way; and building a network chassis to fulfil the fuel reward benefit. All of these barriers have been dealt with and the business is rolling out ahead of expectation. There appears to be a real opportunity to not only build a business of scale and quality, but also to impact society in a real and significant way: creating better drivers and consequently, safer roads. The early results around VitalityDrive™ have exceeded expectation, with 98% of Discovery Insure clients having VitalityDrive™, and within this, levels of engagement have been strong and meaningful correlations found between how policyholders drive and their levels of risk.
In addition, early indications demonstrate that the kind of client attracted to Discovery Insure is typically attracted to Discovery’s other products, with over 60% of clients having three or more Discovery products, excluding Discovery Insure. The implication of this is two-fold: the persistency and behavioural quality of the Discovery Insure client base is superior, and the ability to predict behavioural change from other interactions with Discovery becomes more accurate. This is profound given Discovery’s goal of building a business of scale with significant value based on its ability to price risk accurately and attract quality members.
8. Ping An Health (China)
Ping An Health made significant progress during the period. During the previous year work was done on obtaining the necessary regulatory approvals and establishing the team in China. During the period under review, Ping An Health invested considerably in technology and other infrastructural aspects. In addition to this, the company focused on a number of important product development initiatives and innovations, including a Vitality construct, with these expected to be rolled out in the first and second quarters of 2012.
Despite the infancy of many of the developments, progress made in the market was strong, with new business for the six months of R211 million, the quality of business exceeding expectation, and over 430 000 lives being covered by the end of the period. Ping An Health is now well positioned to capture considerable Group high-end and Individual insurance mid-market business.
Discovery remains excited about the potential of Ping An Health and the ability to build a leading health insurance company in China.
9. The Vitality Group (The United States)
During the period, The Vitality Group made significant progress. Discovery’s intent is to create a scaled-up standalone Vitality capability in the US, given the opportunity created by the inherent centrality of wellness to the US healthcare system.
Discovery’s strategy in the US is to explore a number of distribution channels and partnership opportunities. A seminal development in this regard was the partnership with Humana, which presents Discovery with the opportunity to apply its learnings into a large US Health insurer. During the period, the partnership was successfully rolled out and yielded considerable results in a short space of time: the combination of The Vitality Group’s own distribution channels, in addition to Humana’s distribution, generated in excess of R174 million new business by 31 December 2011, with 1.4 million lives covered by February 2012. In addition, the network is reaching significant scale with over 14 000 partner health clubs and over 2 500 retail locations for members to undergo Vitality Wellness Checks.
Discovery remains optimistic about the prospects of leveraging its intellectual property and assets towards building up a business of scale in the US.
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MI Hilkowitz |
A Gore |