A long way from pasture for Discovery

3/5/2010 12:40:01 PM

Stephen Cranston

In global retailing there is a phenomenon known as the category killer: a chain such as Home Depot or Toys R Us that is so strong it is hard for anyone to compete in its sector. Discovery Health is in such a position in SA medical aid.

Almost 18 years after the business was formed it should be in a mature, stable phase of its life. Yet its new business in the six months to December 31 2009 was up 23%, to R1,79bn. Its membership grew by 5%, to 2,2m.

Discovery Group CEO Adrian Gore says he would have expected some fall-off in membership during harsh economic times, but the annualised lapse rate has actually fallen, from 4,1% to 3,11%.

And despite tough times, only 2% of members are buying down to cheaper health plans.

Discovery, far from being a lumbering giant, continues to take members from sleepier, less innovative schemes. For example, 14% have moved from Oxygen, Old Mutual’s abortive attempt to create a second Discovery, 11% from Bonitas and 7% from Liberty Even Momentum (once Discovery’s parent company), which has built a credible competitor, accounts for 6% of the members who have defected to Discovery.

The Vitality scheme remains an important device for locking members into Discovery. Vitality is not a major profit centre. Operating profit fell 21% during the period, to R26m. But benefits such as cheap gym memberships, flights and reduced prices on healthy food have also helped the growth of the Discovery card, which has a 6,7% market share. That’s similar to Investec and, at current trends, it will overtake Nedbank’s share in barely two years.

There is speculation that Discovery will apply for a banking licence to take control of the card away from First National Bank, which hosts it.

In many respects, Discovery is repeating its success in the health business in Discovery Life. The competitive landscape is much tougher than in health but Discovery Life has focused on the previously neglected risk only business. It has built up a 42% share of severe illness (the polite name for dread disease), 41% of disability income and 34% of disability lump-sum policies.

The trouble with Discovery Life, as independent analyst Risto Ketola points out, is that it burns cash because the cost of acquiring business (in commissions and overheads) is usually more than the cash coming in, in the first year. Additional statutory capital also has to be set aside to cover claims.

Abroad, in fact, Discovery is enjoying more success in the life business than in health, through its joint ventures with Prudential in the UK. PruProtect, which focuses entirely on risk business, has increased its client base from 4300 to 23000 and cut its operating losses by 60%, to R39m.

As in SA, Discovery is focusing on the broker market, which is unhappy with the move by many life offices to direct sales. Over 2009, the number of brokers selling PruProtect increased from fewer than 1000 to 30000.

PruHealth has been much less successful over the past year, with new premium income down 39%, to R165m, and the operating loss almost unchanged in sterling terms.

Discovery has been prudent in its overseas ventures, and even its failed attempt to get into the US market had a limited effect on overall profitability.

But has it become overambitious with its plan to move into the Chinese market? It hopes to buy about 30% of Ping An Health, the health-care arm of Asia’s number two insurer, with 47m clients.

Discovery has product, underwriting and administrative expertise which is useful to Ping An. But there are formidable cultural challenges to such a partnership.

The search for new lines of business is part of Discovery’s entrepreneurial DNA, but some shareholders may wish to see the core businesses giving them more cash: the dividend remains modest and will stay so as long as Discovery doesn’t sit still.