Robust results for Discovery

28 February 2006 Angelo Coppola

Lessons learnt in the USA will be used to good effect in South Africa, as the group flexes its muscles and prepares to take on the big healthcare providers and groups.

* Operating profit up 32%
* Headline earnings per share up 60%
* Once-off cost of R144m for the BEE transaction announced
* 1% drop in net profit to shareholders due to BEE price tag
* The USA operation disappoints difficult time in the last six months
* The UK business performs well
* The Life sector lifts the business high quality business up 29%
* Health business grows
* Vitality performs well
* 300 000 discovery cards in circulation

Adrian Gore, the Discovery group CEO was on hand to provide insights into their interim results, saying that the period has been challenging operationally but the results have been robust.

Discovery Health has shown strong organic growth which has been the key for the first half of the reporting period.

The extent of organic growth in terms of new business is pleasing, although the base was bloated in the previous year, due to a large influx of new corporate business and the once off revenues. The 3% growth in the healthcare business was therefore unexpected, while the life business grew 18%.

New business growth over the last decade has been substantial but the last 2 years have been exceptional. Discovery health is not dominating the contributions in terms of new business, up at the 60% level at the beginning.

Gore was upbeat about the UK operation - PruHealth has lives covered at 35 000 at the end of January. This is good going for a business in its first full year of business. Between 3000 and 5000 lives are being added to the business, monthly.

On the other hand the direct channel in the UK is starting to show good growth from a slow start, and Gore expects that they can reach 1000 new lives covered per month in a relatively short period.

In the USA the story is different a difficult six months as the strategy was off-key and execution was not satisfactory, although Gore maintains that the environment has turned to the benefit of the business. In truth we were boxing way below their weight, and in truth a lot more can be done.

They looked at the business very carefully and considered all the options, including withdrawal. He believes that the new focus will go a long way.

The wave is there, and the assets are unique says Gore.

Financially the membership is growing by 22%, although the costs are increasing, and new business shrank. The issue is the state of Illinois. Fundamentally a mistake was made by entering the state, asit's brutal and the competition is fierce, with Blue Cross, a not for profit organization, getting stronger and stronger.

Blue Cross were able to get better and deeper discounts than the Destiny business could get. thus making it more difficult for the other carriers, including Destiny. Destiny was faster growing than most others, but still not where it should be.

The risk result is where Destiny took the biggest smack. The fix-it was to tighten underwriting, and boldly upping renewals by 20% to 25%, which is extremely difficult to do in a low inflation environment.

In terms of the membership, Gore says that they have increased premiums accordingly, and it's simply a case of they stay at the right price or they go, in terms of those high loss ratio groups.

Profits are what it's all about, and Gore says he won't tolerate non-profitability. So the plan is to reduce the membership numbers and make the business profitable.

At the same time they are entering three other markets, and they are very competitive in Texas, and the mid West is showing good growth. Texas is looking more and more attractive, as a state that doesn't like managed healthcare, and is driven by healthcare activism.

At the core Gore says that the business plan is sound and there is no doubt that the offering is right for the market. There is a pricing problem in Illinois, which is a short term issue.

Discovery Health
I am proud of the performance, with lots of flux and regulation, and we are leaders. Importantly membership grew by 12% and the lapse rate is coming down to close to 3% - which is good news.

The issue is to drive efficiencies and these will addressed as Gore believes there is untapped value there. He expects R50m to R100m in savings in year one and this should drop down to the bottom line.

He talked about the buying power of the business as being the largest player in the healthcare as they are now four times bigger than its nearest competitor, and they can now compete with the hospital groups and other players.

In fact we have the scale and capability to build things ourselves like our team of paramedics.

We will stick to our guns in terms of the rating system for hospitals, and we will use our size to get better deals and discounts, much like whathas been done to the Destiny in the USA, by Blue Cross. We will have a price advantage that no-one can compete with.

Discovery Life
We are excited. The environment is fraught, strategy and implementation has been excellent. R2.2bn in in-force and the risk profit embedded is R220m, in terms of mortality.

There is a lot of cash despite an investment in new ventures. Strategically we are different. 20 years ago there were 20 competitors, now there are just five life assurers operating on the bancassurance model. Big financial conglomerates understand banking but not necessarily life assurance.

Competitors are selling down into the insurance market, and he says that they are a health-assurance play. The embedded value and profits are flowing from the strategy and the quality of premium is also exceptionally good.

The entry into the RA market in this reporting period was seen by cynics as taking advantage of a bad situation. In truth Gore says that the product was in development for two years.

He says that disintermediation is not the way to go. He says they prefer the intermediation process, which adds more value. It's early days yet, but his estimation is 56% of the RA market is sold by brokers and even after such a short period a large number of brokers are moving this product.

Vitality and Discovery card
Strong membership growth in Vitality of 15%, while new partnerships are starting to take shape, such as and a home loan product, with the partnerships adding to the robust results.

Momentum is a competitor. They bring out the best in us; we fight with them on the field. The conflict comes in at the First Rand level. And there are no plans to enter the short-term sector. Our plate is full at the moment, with no plans for entry right now.

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