Is Discovery’s R3.4bn Covid-19 provision enough?

Prior to the release of Discovery’s full-year financial results to end-June, the market already had a solid indication of what to expect.

In mid-June, it warned that it would book an approximate R3.3 billion charge as a reserve for “the potential claims and lapse impact of Covid-19 that are projected to emerge in future periods”.

The final provision is R3.442 billion, with nearly 60% of this comprised of the reserve in the Discovery Life (insurance) book. Two further charges have been booked in the UK health (R713 million) and life (R569 million) insurance businesses with a small R181 million charge in Discovery Invest.

Net of discretionary margins, the profit impact is R2.3 billion.

To arrive at these figures, Discovery estimated the “future mortality, morbidity and economic effects of the pandemic” across the next two financial years (to December 2021) and modelled a variety of scenarios “by setting a stressed, central (prudent best estimate) and light scenario”.

To set the provision, it used the central scenario. It used the stressed scenario to test capital and liquidity. If the result over the coming years was closer to the so-called light scenario, it says there will be a “material release of provisions” in future years.

The experience thus far?

Only 13% of the group’s total life claims provision has been used to date, which equates to around 69% of what it had expected.

In the local life insurance business (Discovery Life), 16% of the claims provision has been used to date. The total provision raised was R1.979 billion, roughly evenly split between lapses and claims. However, if one factors in the R921 million release of margin, the net impact is R1.058 billion.

Source: Discovery Holdings presentation

The group says the “claims reserve is appropriate and sufficient for a potential second wave”. The illustrative progressions for both the group (SA and UK) and Discovery Life (SA only) show this should handily be the case.

Read: Covid-19 hospital admissions cost Discovery R85,000 on average (May 2020)

Actual versus projected deaths in both the Discovery Life and Vitality Life books show that the actual number of deaths will likely be below the medium scenario as modelled.

The further away from this scenario the actual number is – in other words, if there are fewer deaths than expected – the more of the provision on the life insurance claims front Discovery will be able to unwind. Conversely, should conditions deteriorate, it may have to book an additional charge.

In both cases, this will impact earnings but not cash flow.

Source: Discovery Holdings presentation

The provision for Covid-19 across the group (net R2.34 billion) is significant, given that profits from operations for the year totalled R8.4 billion. This equates to 28% of profits.

A far bigger impact on headline earnings was caused by the R4.8 billion charge due to the lowest interest rates in recent history in both SA and the UK.

“Significant movements in positive real rates of return in SA and negative real rates of return in the UK has a significant effect on policy values and headline earnings, but none on cash flows, solvency or capital in SA; and since the implementation of the hedge strategy – little impact in the UK.”

The hedge in the UK gives away any upside for the first 100 basis points (bps) of rates increases, but thereafter there is significant upside as rates rise.

Source: Discovery Holdings presentation

“The impact in the period was R3.6 billion for Discovery Life and £60.5 million net of the valuation of the hedge for Vitality Life, with no bearing on operating performance.”

It expects operating profits in Vitality Life to “revert” to normal levels next year.

Core new business for the year grew by 5% to R19.2 billion.

The group’s established businesses (Discovery Health, Life, Invest and Vitality Health and Life in the UK) were a drag, with new business declining by 5% in the year (Discovery Health and Vitality Health were down by 9% and 8% respectively).

Its emerging businesses (Discovery Insure, Vitality Group and Ping An Health Insurance in China) grew new business by 29%. New business in its so-called new businesses, including Discovery Bank, Vitality Invest, Vitality1, Umbrella Funds and Discovery Business Insurance, was up 114%.

Operating profit was up 8% for the year (to R8.4 billion), but after the Covid-19 charges, it was 22% lower at R6.1 billion.

Headline earnings were 94% lower at R296 million, but after the interest rate charges are unwound (net of tax and the interest rate derivative), the group says normalised headline earnings are down 26% at R3.8 billion.

This article first appeared on Moneyweb and has been republished with permission.

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