Adrian Gore must be wishing for a pretty big umbrella right now, as a cloudburst of bad news pours down on the insurance company he created in 1992. In the past week, Discovery’s share price has fallen 19.6%. Which, in round numbers, means R16.5bn has vaporised in value.
On the face of it, you’d imagine this would be mainly due to the government’s bull-headed insistence on ploughing ahead with National Health Insurance (NHI), the highly optimistic plan for universal health care, which all but destroys the business model for medical aids. Since Gore’s company made R6.9bn from "administering" the eponymous medical aid last year — equal to about 36% of its bottom-line profit — you can see the problem.
But digging deeper, perhaps something else was starting to make waves. On August 5, analysts from Mazi Macquarie published a 36-page report on SA’s life insurance sector, raising some pointed questions about Discovery’s life business.
It gets a bit technical, revolving as it does around arcane accounting principles. But, in broad brush terms, it suggests Discovery is far more "aggressive" than its peers in its accounting — raising the risk for investors.
Essentially, a life insurance business operates on long-term contracts, and the longer the contract, the more uncertain a scenario it is for investors. Macquarie says the contract duration for Sanlam, Old Mutual, Liberty and MMI is around eight to 10 years.
But Discovery, it says, is "the notable exception" — the duration of Discovery’s life insurance contracts is between 10 and 19 years. In fact, says Macquarie, the implied duration of Discovery’s contracts can be up to 40 years. "If the duration ends up being shorter, then Discovery’s balance sheet and retained earnings risk being overstated. The fact is that we won’t know for another three decades. But from an investment perspective, we consider the risk of waiting that long very high," the report says.
Interestingly, Liberty, Sanlam, Old Mutual and MMI told Macquarie that the assumptions they made about contract duration, of around 10 years for their life books, "broadly hold". "Though Discovery’s contract durations are longer, comparative data does not support that they are 30 years longer than peers. This suggests downside risk to Discovery’s investment case," says Macquarie.
But Hylton Kallner, the CEO of Discovery Life, told the FM that suggestions of overly aggressive accounting "are just wrong". The reality, he says, is that the mix of Discovery’s life insurance business is not comparable with that of its peers, and its policies are, on average, just that much longer.
We won’t know for another three decades … We consider the risk of waiting that long very high
"In some cases, policies can last as long as 60 years, if someone takes out a policy when they’re 25 years old. Macquarie has allowed for an average of a 12-year policy term, but our class of business extends far beyond that," he says.
The other companies, such as Old Mutual or Liberty, also offer products, including investment and funeral policies, that are typically for a shorter period than a life policy.
Says Kallner: "Macquarie ignores the fundamental issue, which is that our policies should be valued for the full contract term, which can be for decades, not just the first 12 years. To not take the full term into account would just be incorrect from a valuation and accounting perspective."
Perhaps — but the sharp distinction between Discovery and its peers should, at the least, be something of a red flag. Nor is Macquarie the only one raising concerns about Discovery. Other analysts have also spoken of its "aggressive operating strategy and accounting policy".
Still, Kallner doesn’t attribute the drop in the share price to analyst concerns, but rather to weaker sentiment after the NHI Bill was introduced in parliament. In a nutshell, NHI sketches a picture in which every South African belongs to a state medical fund, financed largely by money that would otherwise have been paid to medical aids. Though there will apparently still be "a role" for medical aids in NHI, it’s not clear what this would be.
Surprisingly, Discovery says it hasn’t actually modelled the potential impact of NHI on its profit. That’s something of a surprise, given that it’s a company teeming with whipsmart actuaries, just itching to model everything from their lunchtime calorie intake to the variables of their route home.
Says Kallner: "In principle, we’re supportive of a policy of universal access to health care. But we’re still going through the detail … It’s too soon to interpret the impact, but we don’t anticipate changes in the foreseeable future."
Which is the diplomatic answer. The reality, as a medical executive told me, is that NHI is "probably a decade away" from being fully implemented. If it ever is — Treasury officials who spoke to the FM said there’s no scope to introduce a new tax right now, like the salary tax envisaged to fund NHI.
Shane Watkins, chief investment officer of All Weather Capital, says NHI is an attempt by the ANC to show it’s delivering on decisions taken at policy conferences. "But the reality is, NHI won’t be rolled out in any meaningful way because it’s unaffordable. As it is, the government says it will be rolled out in 2026, which would give Discovery seven years, at the least, to reconfigure its business," he says.
Still, Watkins says, add NHI to concern about Discovery’s accounting practices, and there are more questions than answers right now.
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