Schoolyard bully or financial services innovator... Is Discovery overstepping the mark?

The 2008/9 global financial crisis has forever changed how we view financial services institutions. It was a crisis rooted in poor lending practices and ridiculous structured debt products that generated a "perfect storm” over US-based banks and mortgage lenders. The rest – as they say – is history.

Almost five years since the word "sub-prime” entered our vocabulary the world remains slave to the resultant financial malaise. Governments and financial policymakers have no answer to the crisis except to throw money at it, through quantitative easing, and cut interest rates to near zero.

We can compare the global financial contagion to an Ice Age, a period of natural selection which only the "intended” will survive. These survivors are the banks and financial institutions viewed by their peers and governments as "too big to fail”.

Wikipedia.org notes that "too big to fail” is a colloquial term for financial institutions that are so large and so interconnected that their failure will be disastrous to the economy! Imagine the self-congratulation as chief executives at the Bank of America, Morgan Stanley and UBS (to name a few) realised they were it. Their reward for bringing the global financial system to the very precipice was immortality.

On the domestic front, South Africa’s big four retail banks would probably fit the "too big to fail” tag… And if we broaden the horizon to included diversified financial services providers we could certainly include the likes of Discovery, MMI Holdings and Sanlam. A collapse in either sector would be disastrous – because banks represent a country’s bricks and mortar – and insurers its citizens’ hopes and dreams.

Discovery Limited is a major player in the domestic medical schemes administration, insurance (long and short-term) and investment landscapes. The question we would like to pose today is whether the group’s healthcare subsidiary Discovery Health is underpinned by a medical scheme that is "too big to fail”?

Discovery Health is the largest of five medical schemes administrators (CMS 2010/11 Annual Report) with 28.9% of market share. It generates an estimated 90% of its operating profit from a single client – the Discovery Health Medical Scheme (DHMS). The scheme boasts more than 2.4 million beneficiaries and comprises some 30% of the domestic medical schemes market, despite being one of a 100 schemes.

Discovery’s dominance of the medical schemes industry has come under the spotlight from time to time. In the past concerns have been raised over the conflicts, real or imagined, of Discovery Health acting as the schemes’ administrator. These concerns contributed to the latest media frenzy after reports that Discovery Health was the most expensive administrator despite its obvious "economies of scale” advantage.

Initial reports on the matter were "botched” and the claim that DHMS paid the highest administration fee of all 100 medical schemes was easily dismissed. Discovery Health chief executive Jonathan Broomberg proudly announced that the administration charge was only (sic) 10th most expensive.

Administrator "value for money” had been raise by DHMS Trustees as early as November 2011 when they agreed to "conduct a detailed, independent review focusing on, amongst other issues, assessing the value for money [from Discovery Health] relative to the medical schemes market.” In a three page statement aimed at clearing up the confusion Milton Streak, Principal Officer of Discovery Health Medical Scheme added that this would be a continuous process.

Streak is adamant the existing relationship makes sense. In his 12 July 2012 statement he said the scheme was a benchmark medical scheme, financially sound, had R7.4 billion in reserves and offered comprehensive benefits and competitive premiums.

"Based on the results and performance of the scheme and these ongoing assessments, the Trustees are of the view that the Scheme and its members are currently obtaining significant value for the fees paid to Discovery Health,” he concluded.

Should DHMS members be concerned? The pro-consumer crowd reckon they should tackle their administrator on two fronts. First – they should ask why the schemes’ administration has not been put out to tender. And second – what has become of the economies of scale that should accrue to a scheme with 2.4 million beneficiaries.

Perhaps the Trustees have missed a point. What they should be asking is the following: If R100 per member per month (say) is a fair fee to pay their administrators, then how could Discovery Health post R989 million in after tax profit for FY2011? If the administration function was run on a "not for profit” basis there would be around R900 million to return to scheme members each year.

Discovery Health’s final word on the matter confirms our "too big to fail” tagline. They say that the administration fee is in line with the market and that DHMS members cannot fault either Discovery Health or the scheme on a quality or affordability of service. This means members will have to accept an administrator that converts an obvious "economies of scale” advantage into a 30% net profit.

As an aside the entire argument is rather nonsensical. Assuming DHMS ring-fenced the costs associated with administration the most it could pass on to its members is around R40 per member per month. The logic holds in the medical schemes broker arena too… Healthcare regulators should drop their obsession with "capping” non-healthcare expenses and focus on the provider side of the equation!

If members of medical schemes are up in arms they should spare a thought for the brokers and intermediaries who interact with Discovery on a daily basis.

Discovery interacts with intermediaries in each of its differentiated businesses. It interacts with life brokers through Discovery Life, financial planners and investment advisers through Discovery Invest, healthcare brokers through Discovery Health – and most recently short-term brokers through Discovery Insure.

You would expect a company of its size to generate a number of complaints – and it does. And to Discovery’s credit we have no more complaints about its antics than any of the other major providers. That said the complaints we have seen in recent suggests the company can give brokers short shrift.

Take, for example, the case of a financial adviser requesting a policy document from Discovery Life. The adviser needs the document to complete the financial needs analysis / advice process with the client – and to ensure compliance with the FAIS Act. He understands that Discovery cannot release said document unless he produces a signed (by the client) FAIS Disclosure form.

Not so! It seems Discovery is withholding this information and referring advisers to Astute. "It is important that intermediaries have access to their client’s financial information so that they are empowered to provide appropriate advice,” says Kenny Rabson, Deputy CEO at Discovery Life. He then goes on to explain why the group could not accede to every request for information.

"Our operational statistics showed that there was a disproportionate strain on the call centre for such requests for client information that could be obtained from Astute, the leading independent electronic information exchange portal for the Financial Services Industry.

"As such, we took a business decision that Astute should be the first port of call for such requests. In instances where there is incomplete information from Astute we duly provide any outstanding information to intermediaries.

These comments make sense from Discovery’s operational perspective. But how should the financial adviser interpret them? Financial advisers are not required by law to sign up for Astute’s services, even though the majority do. By refusing to provide the requested information, Discovery is forcing the broker to incur additional and unnecessary costs.

Also worrying are allegations of broker / client codes being mysteriously changed on Discovery’s systems. Brokers should keep a close eye on their Discovery clients and make sure they remain on the system as the referring adviser!