Discovery’s R3.3bn Covid-19 knock isn’t all bad news

The news that Discovery would book a R3.3 billion provision for the impact of Covid-19, plus the warning that earnings would be down by as much as 90%, sent shares down nearly 6% on Monday. They ended the day down 2.8%, however, broadly in line with the market.

First, as ever with Discovery, the multitude of earnings figures come with a number of adjustments. Normalised headline earnings (excluding the impact of lower rates … more on that later) would only be down 20-30%. This includes the R3.3 billion hit.

On a profit- from-operations basis, the decline will be between 18% and 28% for the year ending June 30. It is worth remembering, however, that operating profit for the six months to end-December was R3.6 billion, down by 7%.

Rewind to last year, and operating profit was R7.7 billion. Using the upper bound of the expected decline, operating profit for this year will be, at worst, R5.5 billion. Remember, this includes the R3.3 billion provision.

Not so bad?

It’s also important to note that the provision is for the future impact of Covid-19, in other words in 2021 and 2022. It says “modelling has been done on a prudent actuarial basis, and is continually being refined by incorporating trends in actual infections and mortality”.

About two-thirds (or R2.2 billion) of the amount set aside is for mortality and morbidity impacts. The other third (about R1.1 billion) is the group’s estimate of “economic stresses, particularly on policy lapses” across its businesses. It says it is using a “central” scenario (not a worst-case one) for the provision, which is larger than most analysts were expecting.

That Discovery is one of the first large insurance providers to raise this provision is telling. If the impacts aren’t as dire, the provision will be released in future periods which will boost earnings (of course, if things get worse, the converse will occur).

Bad

New business is under strain in the South African and UK operations, with this down by 5% and 8% respectively in the 11 months to the end of May. During April and May, the UK life and health businesses (under the Vitality banner) signed new business at between 70% and 80% of the same period a year ago.

In South Africa, the Life business held up best. New business growth slowed at Discovery Health (the engine of the group), “due to minimal new employees being added by existing customers”.

As the consequences of the pandemic ripple through the economy, it is highly likely that Discovery Health will see a material decline in the number of lives administered by its schemes into 2021. At minimum, well-placed estimates see 1 million job losses and an economic contraction of approximately 10%. This will not be good for any medical scheme, least of all the largest in the market.

Less bad

Across the board, it has largely seen fewer policy lapses than expected over the past two months. This was particularly pronounced in the Discovery Insure business. But it’s early days yet.

Separately, excluding the R3.3 billion provision (which is obviously not possible in a global pandemic!), the group’s operating profit will have been up somewhere between 5% and 15%.

The concern for investors is that growth is coming from everywhere but the SA businesses, albeit off much smaller bases.

Good

The group has reported pleasing progress in other new businesses, aside from the bank. These are the umbrella funds and commercial insurance locally, and Vitality Invest in the UK. New business inflows for these are up over 150% to R751 million for the first 11 months of the year.

Its Ping An Health joint venture in China is the sole reason why group new business inflows are positive for the year (up 4% for the 11 months). Exclude this and there’s a 2% decline because of the core SA and UK businesses, despite the inflows from the new initiatives above. Ping An Health has seen an increase of nearly R1 billion in annualised premium income so far this year.

Discovery highlights that “Ping An Health saw its strongest sales throughout the Covid-19 period, to some degree benefitting from the lockdown, as the product can be completed through an online channel, enabling the sales to continue via brokers or direct-to-consumer through Ping An Health’s own app during the lockdown period”.

And what of Discovery Bank, which is a 10-percentage point drag on expected profit growth (excluding Covid-19) this year (5-15% versus 15-25%)?

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