Subject: Demutualisation of The Doctors Health Fund and sale to Avant Group Holdings Limited

Transcription

1 The Directors The Doctors Health Fund Limited 69 Christie Street St Leonards NSW February 2012 Subject: Demutualisation of The Doctors Health Fund and sale to Avant Group Holdings Limited Dear Directors Introduction 1 On 11 August 2011 The Doctors Health Fund Limited (DHF) announced that it and Avant Group Holdings Limited (Avant) had signed an Implementation Deed (the Agreement) under which Avant would become a member of DHF, then the memberships of all DHF Members other than Avant would be cancelled in consideration for payments that would be funded by the agreed consideration of $28.5 million payable by Avant. 2 DHF subsequently received and considered an indicative non-binding proposal from an alternative purchaser1 which: (c) proposed consideration for DHF Members of $30.0 million had other conditions and features which caused the DHF Board to have concerns as to whether it was likely to develop into a Superior Proposal2 caused the DHF Board to: (i) have discussions with the alternative purchaser to clarify elements of their proposal; and (ii) receive advice to help assess whether this proposal was likely to become a Superior Proposal. 3 Discussions were ongoing until the alternative purchaser formally withdrew their indicative offer before the DHF Board reached a view as to whether the alternative purchaser s offer was a Superior Proposal. 1 As discussed in Section 4 of the Scheme Booklet. 2 As defined in the Agreement. Liability limited by a scheme approved under Professional Standards legislation

2 4 On 8 February 2012 the Agreement was amended so that : the agreed price payable by Avant was increased to $30.0 million; and Avant was allowed five business days to submit an amended proposal if the Independent Expert provided a formal opinion that the Scheme was not in the best interests of Scheme Members3 (together with paragraph 1, the Proposal ). 5 The Proposal is subject to conditions precedent including Court, regulatory and member approvals. Details of the conditions are set out in the Agreement (and are summarised in Section I of our report). DHF will convene two meetings of members on the same day for the purposes of the Proposal. The Proposal cannot be implemented unless the resolutions put to each meeting are passed by the requisite majorities. 6 The notices for these meetings, the Resolutions to be considered at these meetings, and the details of how and when DHF Members can vote, are explained in the Scheme Booklet. The Scheme will also need to be approved by the Court. 7 The DHF Board unanimously recommends that DHF Members vote for the EGM Resolutions at the EGM and for the Scheme Resolution at the Scheme Meeting in the absence of a Superior Proposal. The reasons for the DHF directors recommendation are set out in Section 5 of the Scheme Booklet. DHF 8 DHF is a restricted access private health insurer, providing health insurance to Australian medical practitioners their families and employees. Management have advised us that as at 11 August 2011 (being the announcement date), DHF had 7,629 members. Avant 9 Avant is a wholly owned subsidiary of Avant Mutual Group Limited (Avant Mutual) which is a not-for-profit, mutual organisation that currently provides professional indemnity insurance to over 57,000 health professionals including around 55% of Australia s medical practitioners. Avant Mutual reported net assets of $693.3 million at 30 June Purpose of report 10 The Agreement requires that DHF appoint an Independent Expert to opine on whether the Proposal is in the best interests of Scheme Members, and an affirmative view is a condition precedent for the Proposal to proceed. 3 We note that the DHF Members who will receive payments under the Scheme (the Scheme Members) will include all DHF Members who are eligible to vote at the relevant meetings and who remain members at the Scheme Record Date. The Agreement uses the terms DHF Members and Scheme Members. These terms basically refer to the same group of people, viewed at different times. DHF Members are members of DHF at the Record Time and entitled to vote on the EGM Resolutions at the EGM and the Scheme Resolution at the Scheme Meeting. Scheme Members are DHF Members at the Scheme Record Time and Prescribed Members. Refer to the Scheme Booklet for more details on eligibility. 2

3 11 Accordingly, the Directors of DHF have requested that Lonergan Edwards & Associates Limited (LEA) prepare an Independent Expert s Report (IER) stating whether, in our opinion, the Proposal is fair and reasonable and in the best interests of Scheme Members and the reasons for that opinion. 12 LEA is independent of DHF and Avant and has no other involvement or interest in the proposed Scheme. Overview of opinion 13 In our opinion, the Proposal is fair and reasonable and in the best interests of Scheme Members in the absence of a current better proposal. We have formed this opinion for the reasons set out below. Value of DHF 14 We have assessed the value of DHF on a 100% controlling interest basis to be in the range of A$28.4 million to A$31.9 million, as shown below: Value of 100% of DHF Low A$m High A$m Value of health insurance business Regulatory Surplus Capital (1) Value of 100% of DHF Note: 1 Being Regulatory Surplus Capital as at 31 December Fair and reasonable opinion 15 Pursuant to Australian Securities Investments Commission (ASIC) Regulatory Guides4 a scheme is fair if the value of the scheme consideration is equal to or greater than the value of the securities the subject of the scheme. This comparison for DHF is shown below: Position of DHF Low $m High $m Mid-point $m Value of Scheme Consideration Value of 100% of DHF Extent to which the Scheme Consideration exceeds the value of DHF 1.6 (1.9) (0.2) 16 As the Scheme Consideration is within our assessed valuation range for DHF on a 100% controlling interest basis, in our opinion, the Scheme Consideration is fair to Scheme Members when assessed based on the guidelines set out in RG Pursuant to RG 111, a transaction is reasonable if it is fair. 4 In particular Regulatory Guide 111 Content of expert reports (RG 111). 3

4 Best interests 18 In our opinion, the Proposal is in the best interests of Scheme Members in the absence of a current better proposal. In assessing whether the Proposal is in the best interests of Scheme Members, we have had regard to the advantages and disadvantages of the Proposal to Scheme Members, as set out below in our assessment. Assessment of the Proposal 19 We summarise below the likely advantages and disadvantages of the Proposal for Scheme Members. Advantages 20 The Proposal has the following benefits for Scheme Members: (c) (d) (e) (f) the Scheme Consideration of $30.0 million cash is within our assessed value range of DHF on a 100% controlling interest basis the Proposal allows Scheme Members to access the value currently locked inside DHF due to its mutual structure Scheme Members can realise value for their interest in DHF and then apply to join another mutual health fund, if they would prefer to be in a mutual fund the Appointed Actuary s Report which accompanies the Scheme Booklet concludes that as a result of the Proposal: (i) DHF policyholders benefits should remain adequately secure if the Proposal is approved, (ii) future premium rates are unlikely to be impacted in a material manner by the proposal; and (iii) the reasonable benefit expectations of DHF policyholders are unlikely to be impacted in a materially adverse manner by the Proposal. Avant has also agreed (subject to certain conditions) to reimburse various transaction costs associated with the Proposal in addition to the $30.0 million Scheme Consideration although, in certain circumstances, DHF may need to refund reimbursed costs to Avant the ultimate parent (Avant Mutual) has significant similarities to DHF, as it is a mutual organisation focused on health practitioners, with the vast majority of its members being medical practitioners. Disadvantages 21 Scheme Members should note that if the Proposal is approved they will no longer hold an interest in DHF and therefore: will not be able to vote and control the activities of DHF will not participate in any future value created by DHF over and above that reflected in the Scheme Consideration; and 4

5 (c) will not be able to accept any alternative offers which might otherwise emerge. 22 Other disadvantages to Scheme Members that might arise are: there might be tax consequences for Scheme Members, although the advice received by DHF (the Tax Advice Letter set out in Appendix 10 of the Scheme Booklet) is that the amount received by Scheme Members should not be subject to income tax there is a risk that this Proposal might have adverse impact on DHF policyholders even though the Appointed Actuary s Report indicates that a material adverse impact is unlikely. Conclusion 23 Given the above analysis, we consider the Proposal for Avant to become a member of DHF and for all other memberships in DHF to be cancelled in return for payment of the Scheme Consideration by Avant under the Scheme is fair and reasonable and in the best interests of Scheme Members, in the absence of a current better proposal. General 24 In preparing this report we have considered the interests of Scheme Members as a whole. Accordingly, this report only contains general financial advice and does not consider the personal objectives, financial situations or requirements of individual members. 25 The impact of approving the Scheme on the tax position of Scheme Members may vary with the individual circumstances of each member. Scheme Members should read Appendix 10 of the Scheme Booklet (Taxation Advice Letter) and consult their own professional advisers if in doubt as to the taxation consequences of the Scheme. 26 The ultimate decision whether to approve the Scheme should be based on each DHF Members assessment of their own circumstances. If DHF Members are in doubt about the action they should take in relation to the Proposal or matters dealt with in this report, Members should seek independent professional advice. For our full opinion on the Proposal and the reasoning behind our opinion, we recommend that DHF Members read the remainder of our report. Yours faithfully Martin Hall Authorised Representative Tony Coleman Authorised Representative 5

6 Table of contents Section Page I Key terms of the Scheme 8 Terms 8 Conditions 8 Resolution 9 II Scope of our report 11 Purpose 11 Basis of assessment 11 Limitations and reliance on information 12 III Profile of DHF 14 Overview 14 History 14 Current operations 15 Financial performance 17 Financial position 20 IV Australian private health insurance industry 21 Overview 21 Regulation and policy 21 Government initiatives 22 Historical performance of the industry 25 Competition and industry consolidation 26 Outlook 27 V Valuation approach 29 Methodologies selected 30 VI Valuation of DHF 31 Overview 31 Value of PHI business 31 Regulatory Surplus Capital 41 Value of 100% of DHF 41 Valuation cross-checks 42 VII Evaluation of the Proposal 48 Assessment of the Scheme 48 Summary of opinion on the Scheme 50 6

7 Appendices A Financial Services Guide B C Qualifications, declarations and consents Glossary 7

8 I Key terms of the Scheme Terms 27 On 11 August 2011 DHF announced that it and Avant had signed an Implementation Deed (the Agreement) under which Avant would become a member of DHF and all other memberships of DHF would be cancelled under a scheme of arrangement (the Scheme) for an agreed price of $28.5 million, which was subsequently increased to $30.0 million upon amendment of the Agreement on 8 February The Proposal is subject to a number of conditions precedent (as summarised below). 29 If the Scheme is approved by DHF Members and the Court, Scheme Members in aggregate will receive $30.0 million. Conditions 30 The Scheme is subject to the satisfaction of a number of conditions precedent, including the following which are outlined in Clause 2 of the Agreement (as amended): (c) (d) (e) (f) (g) (h) respective regulatory approvals from ASIC, Private Health Insurance Administrative Council (PHIAC), and Australian Government Department of Health and Ageing (DoHA) approval of the Scheme by the Court in accordance with s411(4) of the Corporations Act 2001(Cth) (Corporations Act) DHF Member approval by the requisite majorities of: (i) the EGM Resolutions at the EGM (ii) the Scheme at the Scheme Meeting prior to 8.00am on the Second Court Hearing Date, no judicial authority or entity and no Government Agency taking and not withdrawing any action, or imposing any legal restraint or prohibition, to prevent the implementation of the Scheme (or any transaction contemplated by the Scheme) no DHF Prescribed Occurrence (as defined in Clause 19.1 of the Agreement) occurring with respect to DHF before 5.00pm on the business day prior to the Second Court Hearing Date no Avant Prescribed Occurrence (as defined in Clause 19.1 of the Agreement) occurring with respect to Avant before 5.00pm on the business day prior to the Second Court Hearing Date no DHF Material Adverse Change (as defined in Clause 19.1 of the Agreement) occurring between the date of the Agreement and 8.00am on the Second Court Hearing Date no Avant Material Adverse Change (as defined in Clause 19.1 of the Agreement) occurring between the date of the Agreement and 8.00am on the Second Court Hearing Date 8

9 (i) (j) (k) an independent expert issues a report which concludes that the Scheme is in the best interests of Scheme Members5 the DHF Warranties (as defined in Clause 19.1 of the Agreement) being true and correct on the date of the Agreement and at 8.00am on the Second Court Hearing Date the Avant Warranties (as defined in Clause 19.1 of the Agreement) being true and correct on the date of the Agreement and at 8.00am on the Second Court Hearing Date. 31 In addition DHF has agreed under Clause 12.1 of the Agreement that during the Exclusivity Period6 it will not: solicit, or invite any Competing Proposal or expression of interest or offer or invitation which may lead to a Competing Proposal initiate discussions with any third party with a view to obtaining any expression of interest, offer or proposal from any person in relation to, or which may reasonably be expected to lead to, a Competing Proposal. 32 The exclusivity obligations do not apply if the DHF Board, acting in good faith, determines: (c) that the relevant action is in response to a bona fide Competing Proposal which the DHF Board reasonably believes may lead to a Superior Proposal and which was not solicited or invited in contravention of Clause 12.1 of the Agreement; or the relevant action is in response to a bona fide third party expression of interest or offer or invitation or proposal with respect to a transaction which the DHF Board reasonably expects to lead to a Competing Proposal, which the DHF Board reasonably believes may lead to a Superior Proposal and which was not solicited or invited in contravention of Clause 12.1 of the Agreement; and after receiving written legal advice from DHF s external legal advisers in respect of its legal obligations (including fiduciary and statutory duties), that failing to respond to the Competing Proposal, expression of interest, offer, invitation or proposal would, or might reasonably be expected to, involve a breach of its legal obligations (including fiduciary or statutory duties). For the avoidance of doubt, this clause does not constitute a waiver of legal privilege in respect of any such legal advice. Resolution 33 As set out in the Scheme Booklet, DHF Members will be asked to vote on: the EGM Resolutions at the EGM (to change DHF s Constitution to facilitate the demutualisation of DHF) 5 Altered as part of the amendment on 8 February 2012 so that if the Independent Expert provided a formal opinion that the Scheme was not in the best interests of Scheme Members, then Avant would have five business days to submit an amended proposal to DHF, with the Agreement only ceasing if the Independent Expert does not opine that the revised proposal is in the best interests of Scheme Members. 6 Being the earlier of termination of the Agreement or 31 May

10 the Scheme at the Scheme Meeting (to demutualise and transfer ownership of DHF to Avant). 34 If the resolutions are passed by the requisite majorities, DHF must apply to the Court for orders approving the Scheme, and if that approval is given, lodge the orders with ASIC and do all things necessary to give effect to the Scheme. Once the Court approves the Scheme it will become binding on all DHF Members whether or not they voted for the Scheme (and even if they voted against the Scheme). 10

11 II Scope of our report Purpose 35 The Scheme is to be effected pursuant to Part 5.1 of the Corporations Act, which governs schemes of arrangement. Part 3 of Schedule 8 of the Corporations Regulations 2001 (Corporations Regulations) prescribes information to be sent to shareholders in relation to a members scheme of arrangement pursuant to s411 of the Corporations Act. 36 Both a condition precedent to the Scheme and the DHF Directors recommendation of the Scheme are subject to an Independent Expert concluding that the Scheme is in the best interests of Scheme Members. In addition, as the Scheme (if approved and implemented) will result in 100% of the securities in DHF being held by Avant, RG 111 requires that we provide an opinion on whether the consideration payable under the Scheme is fair and reasonable to the Scheme Members. 37 The Directors of DHF have therefore requested LEA to prepare an IER stating whether the Proposal is fair and reasonable and in the best interests of Scheme Members and the reasons for that opinion. 38 This report has been prepared by LEA for the benefit of the Directors of DHF and the DHF Members to assist them in considering the Proposal. A summary of our report will accompany the Scheme Booklet to be sent to DHF Members. The sole purpose of our report is to determine whether, in our opinion, the Proposal is fair and reasonable and in the best interests of Scheme Members. 39 The ultimate decision whether to approve the Scheme should be based on each DHF Member s assessment of their own circumstances. If in doubt about the action they should take in relation to the Proposal or matters dealt with in this report, Members should seek independent professional advice. Basis of assessment 40 In preparing our report we have given due consideration to the Regulatory Guides issued by ASIC including, in particular, RG RG 111 distinguishes fair from reasonable and considers: the scheme to be fair if the value of the scheme consideration is equal to or greater than the value of the securities that are the subject of the scheme. A comparison must be made assuming 100% ownership of the target the scheme to be reasonable if it is fair. The scheme may also be reasonable if, despite not being fair but after considering other significant factors, there are sufficient reasons for security holders7 to approve the scheme in the absence of a current better proposal. 7 RG 111 refers to securityholders because it is a general guide covering expert reports on companies as well as other entities. In the context of the Proposal, DHF Members would be securityholders in the RG 111 terminology. 11

12 42 There is no legal definition of the expression in the best interests. However, RG 111 states that a scheme may be in the best interests of the members of the company if there are sufficient reasons for securityholders to vote in favour of the scheme in the absence of a higher offer. 43 In our opinion, if the Scheme is fair and reasonable under RG 111 it must also be in the best interests of Scheme Members, provided there is no material detriment to their position as policyholders in DHF, and in the absence of a current better proposal. 44 Our report has therefore considered: (c) (d) (e) (f) (g) the market value of 100% of DHF the value of the Scheme Consideration offered by Avant the extent to which and differ (in order to assess whether the Scheme is fair under RG 111) the extent to which Scheme Members are being paid a share of any synergies likely to be generated pursuant to the potential transaction the value of DHF to an alternative offeror and the likelihood of a higher alternative offer being made for DHF prior to the date of the Scheme meeting the advantages and disadvantages of the Scheme from the perspective of DHF Members other qualitative and strategic issues associated with the Scheme. Limitations and reliance on information 45 Our opinions are based on the economic, sharemarket, financial and other conditions and expectations prevailing at the date of this report. Such conditions can change significantly over relatively short periods of time. 46 Our report is also based upon financial and other information provided by DHF and its advisers. We understand the accounting and other financial information that was provided to us has been prepared in accordance with the Australian equivalents to International Financial Reporting Standards (AIFRS). We have considered and relied upon this information and believe that the information provided is reliable, complete and not misleading and we have no reason to believe that material facts have been withheld. 47 The information provided was evaluated through analysis, enquiry and review to the extent considered appropriate for the purpose of forming an opinion on the Scheme from the perspective of DHF policyholders, all of whom are DHF Members. However, we do not warrant that our enquiries have identified or verified all of the matters which an audit, extensive examination or due diligence investigation might disclose. Whilst LEA has made what it considers to be appropriate enquiries for the purpose of forming its opinion, due diligence of the type undertaken by companies and their advisers in relation to (for example) prospectuses or profit forecasts is beyond the scope of an IER. 48 Accordingly, this report and the opinions expressed therein should be considered more in the nature of an overall review of the anticipated commercial and financial implications of the proposed transaction, rather than a comprehensive audit or investigation of detailed matters. 12

13 49 An important part of the information base used in forming an opinion of the kind expressed in this report is comprised of the opinions and judgement of management of the relevant companies. This type of information has also been evaluated through analysis, enquiry and review to the extent practical. However, it must be recognised that such information is not always capable of external verification or validation. 50 In forming our opinion, we have also assumed that: the information set out in the Scheme Booklet is complete, accurate and fairly presented in all material respects if the Scheme becomes legally effective, it will be implemented in accordance with the terms set out in the Agreement and the terms of the Scheme itself. 13

14 III Profile of DHF Overview 51 DHF is a niche provider of private health insurance for the Australian medical community. DHF offers hospital and general treatment insurance products to protect members from health related incidents and conditions. At present DHF is structured as a mutual and registered as a restricted access not-for-profit private health insurer. History 52 DHF commenced operations in 1977 as an initiative of the New South Wales branch of the Australian Medical Association. Prior to 2006, DHF focussed on serving the insurance needs of the medical community, with minimal promotion and marketing of the fund to increase brand awareness. In 2006 DHF embarked on a growth strategy in order to capitalise on increased scale and reduce the risks associated with an older membership base. As a part of this strategy DHF targeted a younger market, as well as the eligible non-doctor relatives and employees of medical practitioners8. DHF continues as a pure-play private health insurer9 and only provides hospital and general treatment insurance. 53 Membership numbers remained relatively constant to 2005, after which the benefits of the growth strategy are evident, with member numbers increasing significantly as shown graphically below: DHF membership growth (1) 9,000 7,492 7,200 6,410 5,741 5,400 4,177 4,140 4,113 4,189 4,276 4,357 4,465 4,661 5,138 3,600 1,800-20% 10% Growth in members - (10%) Note: 1 Includes members which have purchased only general treatment insurance products. Source: DHF management. 8 The partner, child, grandchild, parent, sibling or employee of a medical practitioner is eligible to join DHF. 9 DHF provides a facility on its website for members to access QBE travel insurance, but only as an agent for QBE. 14

15 Current operations 54 DHF is based in Sydney and due to its niche target market has a relatively small market share of 0.2% of the Australian private health insurance industry10. DHF is licensed under the Private Health Insurance Act 2007 (PHI Act) to provide health insurance services to contributors and to invest and manage funds held by the company. DHF s portfolio of health insurance products include: (c) (d) Top Cover a premium cover including benefits for hospital in-patient medical services paid up to the Australian Medical Association (AMA) list of services and fees. There are no excess and no exclusions or restrictions for services eligible for Medicare benefits. This product is unique and differentiates DHF from the market Prime Choice provides hospital cover up to the Australian Health Service Alliance (AHSA) access gap cover fee schedule, with no exclusions or restrictions for services eligible for Medicare benefits. This product is equivalent to most other fund s premium products. There are currently two options with Prime Choice cover, with and without an excess Smart Starter an entry level hospital product that provides cover up to the AHSA access gap cover fee schedule, but there are some exclusions and restrictions and an excess general treatment products include options for Total Extras or Essential Extras that can be bundled with the abovementioned products. General treatment products include, inter alia, dental, optical, hearing, physiotherapy and psychology services. 55 DHF traditionally and continues to market its products through medical channels such as hospitals, medical events and relevant media advertising. Growth in recent years was supplemented by employing the services of an insurance intermediary, being iselect. iselect provides an online-based health insurance selection service, where purchases are based on a combination of price and benefit structure. 56 DHF is currently a member of the AHSA which negotiates with hospitals and other medical service providers on behalf of its 27 members health funds. DHF is also a member of the Health Insurance Restricted Membership Association of Australia (HIRMAA) which lobbies the Government and its agencies on behalf of its community based not-for-profit health fund members. 57 DHF currently meets its information technology (IT) and systems needs through Hospital and Medical Benefits Systems (HAMBS). HAMBS is a not-for-profit system provider owned by its users, which include GMHBA Ltd (GMHBA), Teachers Federation Health Ltd (Teachers), Defence Health Ltd (Defence) and a number of smaller funds (including DHF). This allows DHF access to IT processes and support at a competitive cost, not otherwise available to an organisation of its size. 10 Measured by premium revenue. 15

16 Members 58 As at 30 June 2011 there were 7,492 members in DHF11, of which 7,425 were hospital contributors and 4,706 were general treatment contributors12. DHF s membership is split between product offerings as set out graphically below: DHF membership split between products As at 30 June % 80% Smart Starter Essential extras 60% Prime Choice 40% Total extras 20% Top Cover Source: DHF management. - Hospital cover General treatment cover 59 Notwithstanding that DHF was established and based in NSW (where operations are still based), membership numbers in other states are high, as shown below: DHF membership distribution by state As at 30 June 2011 SA 2% ACT 2% WA 2% TAS 1% NT 0.4% QLD 20% NSW 39% VIC 34% Source: DHF management. 11 As at 11 August 2011 there were 7,629 members in DHF. 12 Many members have both hospital and general cover. 16

17 60 DHF was initially established by medical practitioners to provide health insurance products for medical practitioners. However, as membership eligibility extends to the non-doctor relatives and employees of a medical practitioner, doctors currently only make up approximately two-thirds of the membership base. 61 DHF s strategy to target a younger market and its initiative to expand its member numbers has continued into As at 30 June 2011, the average age of members had fallen to 49.1 years (which is, however, still higher than the general industry average) and the number of members that held Single policies had increased to make up almost half of all members. The change in membership demographics is in line with the more recent observed trend of new members being less likely to select Top Cover, and instead tending to select the cheaper and less comprehensive Prime Choice and Smart Starter. Despite this trend, the termination rates are low for the higher benefit Top Cover. Financial performance 62 The financial performance of DHF for the four years to 30 June 2011 (FY11) and the six months to 31 December 2011 is set out below: DHF financial performance FY08 FY09 FY10 FY11 6 mths to Dec 11 $000 $000 $000 $000 $000 Contribution income 15,806 18,169 20,805 25,044 14,578 Direct claims expense (14,272) (17,511) (19,768) (22,340) (11,384) Ambulance levies (212) (232) (255) (290) (159) RETF recoveries (1) 2,076 2,626 2,779 2, Net claims expense (12,408) (15,117) (17,244) (20,470) (11,054) Gross underwriting profit 3,399 3,052 3,561 4,574 3,524 Claims handling costs (1,327) (1,032) (1,093) (756) (353) Acquisition cost (827) (618) (551) (757) (355) Other underwriting expenses (1,182) (1,058) (1,102) (1,762) (1,008) Total management costs (2) (3,336) (2,708) (2,746) (3,275) (1,716) Underwriting profit ,299 1,808 Investment income 1,093 1,518 1,500 1, Other income Profit before tax (PBT) (3) 1,157 1,865 2,363 3,087 2,776 Unexpired risk liability (4) - (278) Reported PBT (3) 1,157 1,587 2,641 3,087 2,776 Key performance indicators (%) Growth in contribution income Net claims expense ratio (5) Gross margin (5)

18 DHF financial performance FY08 FY09 FY10 FY11 6 mths to Dec 11 $000 $000 $000 $000 $000 Management expense ratio (MER) (5) Net underwriting profit ratio (5) Operating surplus ratio (6) Note: 1 The Risk Equalisation Trust Fund (RETF) is a pool of monies established on 1 April 2007 that is used for sharing the hospital treatment costs of high-risk groups (such as age based pool) and high cost claims. DHF receives subsidies from the RETF for members older than 55 years of age (the amount of subsidy increases in eight age bands above this age). 2 The allocation methodology for expense by function is changed in FY11 based on management s interpretation of PHIAC guidance for annual returns. If the same methodology was used for FY10, the acquisition costs, claims handling costs and other underwriting expenses for FY10 would have been $433,471, $634,247 and $1,678,624 respectively. 3 As a non-profit mutual company DHF does not pay income tax. 4 The reversal of an unexpired risk liability recognised in FY09 and released in FY10. 5 As a percentage of contribution revenue. 6 PBT (before significant items) as a percentage of contribution revenue. Totals may not add due to rounding. Source: DHF Annual Reports for FY11, FY10 and FY09 and DHF management accounts for the six months to December DHF s contribution income has increased by around 15% to 20% per annum over the above period, which is in line with DHF s strategic intent to achieve membership growth and benefits of scale. The compound annual growth rate (CAGR) of contribution revenue (16.5%) exceeds the CAGR in the number of members (12.6%) over the period primarily due to rate increases. 64 Gross margins have remained relatively stable over the period, ranging between 17% and 24%. With regard to this we note that: (c) (d) notwithstanding higher growth in the less profitable Prime Choice and Smart Starter products, the profitability of these products is improving due to the lower claims costs of the younger members who are taking up these products Top Cover is the most profitable product and has recently experienced the slowest growth, relative to the other products DHF has introduced an option to pay premiums monthly, which will reduce the number of policies that receive a discount for payment of premiums in advance, but will also affect investment income earned on pre-paid premiums the movement of the outstanding claims provision during FY11 was affected by the release of an excessive provision held at 30 June 2010 of some $418,000, which increased the reported FY11 gross margin by some 1.7%. 18

19 65 The underwriting result improved from 0.4% in FY08 to 5.2% in FY11, primarily due to: (c) acquisition costs per member, based on net growth numbers13, reducing by more than half over the period. That is, the cost involved in marketing and related activities to gain new members and retain existing members has fallen substantially on a per net new member basis an increased ability to leverage off its fixed-cost base as management expenses have significant components which are fixed in nature a one-off effect of the release of outstanding claims provision in FY11, without which the net margin would have been some 3.5%. 66 DHF s investment returns have outperformed typical share market returns over recent years despite the low-risk low-return nature of DHF s investments which are primarily term deposits with Australian banks. In contrast the global financial crisis (GFC) caused defaults on some lower grade investments, large falls in equity prices and cuts to company dividends. Management expense ratios 67 The management expense ratio is the operating expense incurred in the course of a normal fund s operations (such as salaries, rent, IT costs etc) as a percentage of premium income. The following chart summarises the management expense ratios of the major competitors in the industry compared with DHF: Major private health insurers management expenses FY09, FY10 and FY11 20% Industry average 2011 (9.1%) 16% 12% 8% 14.9% 13.2% 13.1% 9.3% 9.4% 9.7% 9.2% 9.3% 8.9% 7.8% 7.3% 6.9% 11.5% 10.0% 9.4% 9.9% 9.6% 9.9% 9.9% 9.3% 9.1% 4% 0% Doctors Health Fund Medibank Private BUPA Aust. Health Source: PHIAC, Operations of the Private Health Insurers, Annual Report HCF HBF NIB Aust. Unity 13 Net growth numbers refers to the number of new members less the number of terminations. 19

20 68 DHF s management expense ratio is higher than the industry average primarily due to the smaller scale of DHF s operations and the ongoing capital expenditure required to support the rapid growth in recent years. In contrast, the operations of other major private health insurers are more mature and substantially larger, allowing them to capitalise on the benefits of scale. DHF has continued to achieve significant reductions in its management expense ratio in recent years as a result of its growing operations and the associated benefits of scale. Financial position 69 The financial position of DHF as at 30 June 2009, 30 June 2010, 30 June 2011 and 31 December 2011 is set out below: DHF financial position 30 Jun Jun Jun Dec 11 $000 $000 $000 $000 Cash and cash equivalents Trade and other receivables 1,812 2,439 3,066 2,091 Financial assets at fair value 20,700 23,600 26,899 30,589 Plant and equipment Total assets 22,848 26,283 30,609 33,458 Trade and other payables Provision for employee benefits Unearned premium liability 6,224 7,057 8,064 8,434 Unexpired risk liability Outstanding claims liabilities 1,832 1,994 2,159 1,974 Total liabilities 8,687 9,481 10,720 10,793 Net assets 14,161 16,802 19,889 22,665 Note: Totals may not add due to rounding. 70 In respect of the above we note: (c) trade receivables include interest receivables, receivables for the 30% Government rebate14, premiums in arrears, receivables from the RETF and receivables for the goods and services tax (GST) financial assets members contributions are invested in financial products. As at 30 June 2011, DHF primarily holds investments in A-rated15 or higher term deposits with Australian banks and financial institutions outstanding claims liabilities the reserves for payment of estimated private health insurance benefits payable to members for services rendered to the members to date. 14 A 30% Federal Government rebate is available for individuals and families that pay private health premiums. DHF receives this rebate directly from the Federal Government on behalf of its members. 15 As per Standard & Poors ratings. 20