L - Revisiting CNA Financial: An Attractive Company For Dividend Income Investors

Summary

• CNA Financial is a resilient insurer, benefiting from a strong position in niche markets, and it generates steady cash flows.
• Those cash flows are redistributed via an attractive dividend policy, decided by Loews Corporation, which owns 90% of the listed insurer.
• Although the potential upside is limited, as the company is majority-owned by another company, the company remains an attractive choice for any dividend seekers.

CNA Financial - Revisiting the business

CNA Financial (CNA) is one of the largest U.S. commercial property and casualty (also known as "P&C") insurance companies.

Backed by more than 120 years of experience, CNA provides a broad range of standard and specialized insurance products and services for businesses and professionals in the U.S., Canada, and Europe.

The insurer mainly focuses on specialty and commercial lines, representing almost 90% of the total property and casualty insurance business.

Despite a drop in the book value in 2022, driven by the decline in unrealized gains from the fixed-income portfolio, the insurance company is a resilient player in the insurance industry, succeeding in maintaining one of the best underwriting margins of the P&C insurance industry over the cycle.

However, the potential upside is more-than-limited; the insurer is one of the subsidiaries of Loews ( L ), which owns 89.6% of the company. Hence, all the capital allocation decisions are driven by Loews' strategy. Current shareholders of the P&C insurance company might only enjoy the juicy dividend, composed of a quarterly distribution plus a variable distribution, without expecting a boom in the company's valuation.

A Steady Underwriting Performance, Improved Again in 2022

As I have said many times, it is better to have a non-growing insurance company with high margins instead of an insurer that increases its revenues by 10% yearly but by deteriorating its underwriting performance.

How does CNA succeed in delivering a positive underwriting performance over the years? The reason is simple; CNA's portfolio is well-diversified and has a hidden gem: its specialty insurance portfolio.

The specialty insurance portfolio is well-managed, highly profitable, and focused on niche markets, like surety business, healthcare insurance segment, or alternative risks.

From 2015 to 2021, the combined ratio was almost always equal to or below 90%. The only exception was in 2020 when the company suffered an increase in claims activity due to COVID-19.

Although the claims activity was higher in 2020 than in prior years, the combined ratio remained excellent.

For the first nine months of 2022, the specialty segment continued to record impressive results, with a year-to-date combined ratio of 89.8%, resulting in an underwriting gain of $273 million, or 64% of the YTD underwriting income of the P&C operations.

The non-life activities posted an underwriting gain of $425 million for the year's first nine months, less affected by the catastrophe losses than other insurers.

The improvement of the combined ratio (from 97.4% in 9M2021 to 93% in 9M2022) was driven by three effects:

• Steady results from the specialty business, which is the cash cow of the insurance company.
• The improvement of the commercial insurance segment results, driven by the underwriting and pricing initiatives, despite a loss-making third quarter, which reduced the YTD underwriting income to $94 million.
• Improved loss ratios in the international divisions, driven by underwriting decisions and the tariff increases negotiated during last year's renewal period. The YTD combined ratio amounted to 96.6%, resulting in an underwriting income of $58 million.

Despite the adverse costs of Hurricane Ian, accounting for $87 million of the total P&C operations, the insurer is well-positioned to deliver higher-than-2021 underwriting results, despite reduced investment income.

Volatile Investment Income

While the insurance company benefited from the equity market rises in 2021, the investment return in 2022 (at least for the first nine months of the year) was lower. Net investment income decreased $91 million and $306 million for the three and nine months ended September 30, 2022, as compared with the same periods in 2021, driven by unfavorable limited partnership and common stock results partially offset by higher income from fixed income securities.

Going forward, with the interest rate increases, the fixed-income portfolio is expected to generate higher returns over the next quarters, partially compensating for potential drops from the equity portfolio.

Dividend Policy: Serving Loews' Capital Allocation Interests

As mentioned at the beginning of the analysis, CNA Financial is almost 90% owned by Loews.

In other words, CNA is at the mercy of Loews' good or bad decisions regarding capital allocation.

Loews has been using CNA as a money pump in my view; the insurer pays out hefty dividends to its shareholders to allow Loews to invest in new businesses and actively buy back its shares.

Likely to serve Loews' best interests, CNA Financial used to pay a quarterly cash dividend, which has been maintained or increased since 2015. On top of the regular quarterly dividend, CNA Financial redistributes the capital excess via a special dividend, announced after the fourth-quarter results.

In 2022, CNA Financial shareholders received a $3.6 dividend per share, including the $2.0 special dividend. For 2023, based on the FY2022 results and the 2023 expectations regarding the underwriting performance, the company might announce a 3 to 5% dividend increase, plus a $2 special dividend per share. Although the dividend policy might depend on the macroeconomic situation and Loews' capital allocation plans, I think CNA shareholders might enjoy a total dividend payment of circa $3.65 to $3.68 per share in 2023. Based on the current share price, the forward dividend yield would be around 8.7% to 8.8%.

Small Potential Upside But Recurring Dividend Income

CNA Financial is neither a fast-growing insurance company nor an undervalued stock. CNA shares are traded at around 1.2 - 1.4 times the book value (BPVS at 9M2022: $29.88). The upside potential is quite limited, as the company is majority-owned by another company. Nonetheless, the insurer generates recurring cash flows due to steady positions in niche markets, which allow it to redistribute the capital excess to its shareholders over the cycle without endangering its solvency position. In my opinion, CNA remains a good option for all retirees or dividend-oriented investors, which might consider buying the stock when it is traded at circa 1.0 times the book value if they want to purchase a portion of the company with a safety margin.

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