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Rating Action:

Moody's assigns Aa3.za issuer rating to Discovery Limited

20 Oct 2017

London, 20 October 2017 -- Moody's Investors Service, ("Moody's") has assigned Ba1 global scale and Aa3.za national scale Long-Term Issuer ratings to Discovery Limited (Discovery). The outlook for Discovery is negative, in-line with that of the Government of South Africa (Baa3, negative).

Discovery is a diversified financial services group that is based in South Africa, and has a growing presence in international markets through its Vitality brand and platform. Discovery's South African operations primarily span healthcare, as administrator and managed care provider to a number of local medical schemes, life insurance, savings and investments, general insurance and lending. Discovery is in the process of launching a new South African bank. The group also serves the UK life and health insurance markets through its wholly-owned UK domiciled insurers that operate under the Vitality brand, based on Discovery's shared value insurance model.

RATINGS RATIONALE

Discovery's Ba1 and Aa3.za national scale long-term issuer (LT Issuer) ratings reflect (i) group's very strong franchise in South Africa and its growing global footprint, (ii) its strong profitability and significant non-insurance fee income from Discovery Health, (iii) moderate exposure to local investments because of the capital-light nature of its business, and (iv) good capitalization on both a regulatory and economic basis. These strengths are partially offset by (i) the group's substantial business exposure to South Africa and the challenging operating environment, (ii) complexity inherent in its shared value insurance model, and (iii) ambitious expansion initiatives that present execution risk and require significant amounts of external funding.

Discovery has built a leading market position in the retail affluent segment of the South African insurance market, through its philosophy of shared value insurance. The high customer appeal of its insurance and other financial products is enhanced by the Vitality program which is the tool by which the group implements the shared value model. Through Vitality, Discovery is able to incentivize and track desired policyholder behaviour, ultimately incorporating outcomes into its pricing decisions. Because of the incentives provided by Vitality, the Group has been successful at encouraging customers to purchase multiple Discovery products, and has also benefited from positive selection and good persistency.

The group's profitability is strong, driven by its product mix, market leading franchise and customer appeal of the Vitality program and benefits. In addition, Discovery benefits from significant diversification of its operating profit across different lines of business, including Discovery Health (~36%), Discovery Life (~51%), and Vitality (UK) (~11%). The group also has a growing presence in a number of other global markets, through its Vitality Partner Markets platform, whereby it partners with local insurers to deliver products based on the Vitality shared value insurance model. We expect this to further increase its diversification over time.

We consider the group's capital adequacy to be strong, primarily due to its solid regulatory and economic capital levels and its resilience to a range of stress scenarios. Sensitivity of the group's capitalization to asset price shocks is lower than some other insurers, primarily due to the predominance of unit-linked and term life products in Discovery Life's business and the low asset leverage associated with these products. Lapses and underwriting risk, which could manifest in higher than expected mortality and/ or morbidity experience, are the key risks to the group's capitalisation.

The group's ambitious expansion strategy, and development of new business lines, relies on external debt funding, serviced by cash generated from its mature and profitable existing businesses. Given the group's large investments expected in Vitality Life (UK), Vitality Partner Markets, and the Discovery Bank over the next 3 years, we expect debt leverage to increase over the next 2 to 3 years before gradually returning closer to current levels. In addition, we expect the investment in new business lines to suppress return on capital over the next 2 to 3 years, even as absolute profitability is expected to increase meaningfully.

NOTCHING AND CONSIDERATION OF THE SOVEREIGN CONSTRAINT

Discovery's Ba1 long-term Issuer rating is derived from a Baa2 notional Insurance Financial Strength Rating (IFSR), which serves as the baseline or anchor rating for the group. Because the significant majority of Discovery's operating profit (~90%) and financial assets are South African based, similar to its peers, Discovery's notional IFSR is constrained by the rating of South Africa. However, our Baa2 notional IFSR for Discovery is one-notch above the sovereign rating of the Government of South Africa, and reflects our view that Discovery's diverse business mix, significant fee income and moderate asset leverage reduces the exposure to South African sovereign risk.

While the group's current business profile supports a notional IFSR above the sovereign rating, the addition of a local bank to the group could increase the linkage to the sovereign over time, potentially resulting in the group's notional IFSR becoming more constrained by the sovereign. We consider local banks to be inextricably linked to the sovereign, and as such their baseline credit assessments (bca) are capped by the sovereign rating. As Discovery's bank - expected to launch during 2018 - grows, we will monitor the size of the bank's assets relative to the rest of the group. That notwithstanding, our current view is that increased linkage to the sovereign, because of growth in the bank, will be offset by expected growth in Discovery's non-South African business.

The Ba1 long-term Issuer rating is two notches lower than the Baa2 notional IFSR, the anchor rating from which it is derived, and reflects narrower notching than Moody's standard notching (three notches) for insurance group senior debt. The narrower notching is supported by significant cash flows from Discovery Health, which generates non-insurance fee income that comprises ~36% of the group's operating profit, and generates well in excess of 50% of the group's cashflows. Significant cash flow from non-insurance operations, that are therefore not constrained by insurance regulation, allows narrower notching because it limits the structural subordination of holding company creditors to policyholders of the regulated insurance subsidiaries.

RATING OUTLOOK

The negative outlook for Discovery reflects the negative outlook on the South African sovereign, and the linkage between Discovery and South Africa. The negative outlook on the South African sovereign reflects Moody's view that the risks to growth and fiscal strength arising from the political outlook are tilted to the downside.

MAPPING FROM THE GLOBAL TO THE NATIONAL SCALE

Discovery's Aa3.za national scale LT Issuer rating is based on the application of Moody's mapping criteria for a Ba1 global scale IFS rating to the South African national scale. The rating is mapped to the lower end of the national scale rating range, reflecting execution risk inherent in the group's expansion plans and the expected increase in debt leverage necessary to fund the expansion.

FACTORS THAT COULD CHANGE THE RATING - UP

- An upgrade of the rating of the Government of South Africa

- Increased geographic diversification, evidenced by the majority of the group's profits being generated outside of South Africa on a sustainable basis

FACTORS THAT COULD CHANGE THE RATING - DOWN

- A downgrade of the Government of South Africa's rating

- Material uncertainty about the sustainability of the fee income generated by Discovery Health, including loss of the management contract with Discovery Health Medical Scheme (DHMS), or material deterioration in expected earnings due to implementation of National Health Insurance in South Africa

- Sustained increase in the group's financial leverage, meaningfully beyond its 28% Financial Leverage Metric

- Rapid growth in banking assets that decreases the group's resilience to sovereign-related stress scenarios

- Material weakening in the group's franchise, including evidence that casts doubt on the viability of the "Shared Value Insurance Model"

LIST OF NEW RATINGS

The following new ratings were assigned in this action:

Rating assigned on the global scale:

Discovery Limited long-term issuer rating at Ba1

Rating assigned on the national scale:

Discovery Limited long-term issuer rating at Aa3.za

..Outlook assigned: Negative

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Global Life Insurers published in April 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Moody's National Scale Credit Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody's global scale credit ratings in that they are not globally comparable with the full universe of Moody's rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a ".nn" country modifier signifying the relevant country, as in ".za" for South Africa. For further information on Moody's approach to national scale credit ratings, please refer to Moody's Credit rating Methodology published in May 2016 entitled "Mapping National Scale Ratings from Global Scale Ratings". While NSRs have no inherent absolute meaning in terms of default risk or expected loss, a historical probability of default consistent with a given NSR can be inferred from the GSR to which it maps back at that particular point in time. For information on the historical default rates associated with different global scale rating categories over different investment horizons, please see https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1060333.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Brandan Holmes
Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Antonello Aquino
Associate Managing Director
Financial Institutions Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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