On the 5th of November, CNA Financial (CNA) reported its quarterly results for the third quarter of the year. Experiencing lower catastrophe losses than the same period last year, the core income grew by about 83% to $305 million in Q3 2018. On a year-to-date basis, the net profit rose by 32.7% to $897 million, benefiting from a lower corporate tax rate and lower catastrophe losses. Furthermore, CNA Financial declared a quarterly dividend of $0.35 per share, in line with previous. Hence, the P&C insurer continued to reward its shareholders.
With a safe and attractive dividend, a continuous improvement in the underwriting margins, CNA Financial is on the road to be valued by Mr. Market at $50 per share, or 1.2 times the actual book value per share. In my opinion, I still consider that a stock price equal to 1.0 times the book value is a fair price, regarding the historical valuation ratio average and because of the underlying risks of the company. For example, CNA's dividend policy depends entirely on the decisions made by Loews Corporation (L), the largest shareholder of the P&C insurer; furthermore, there are continuous expectations of the shareholders regarding the dividend growth. Nonetheless, some dividend seekers could think that paying 1.2 times the book value to acquire stocks of this 6% implied yielder is not so expensive.
Improved Underwriting Margins Thanks To Lower Catastrophe Losses
During the third quarter of 2017, CNA, like many other P&C insurers, was affected by costly catastrophes and reported a quarterly combined ratio of 103.7%. The year-to-date combined ratio was indeed affected negatively and deteriorated to 98.2%.
In Q3 2018, the situation changed slightly. The quarterly combined ratio amounted to 94.2% or a 9.5 percentage point improvement on a year-to-year basis. The underwriting gain was $100 million vs. a $61 million loss one year ago.
The growth in the underwriting results was mainly driven by the lower effects of the catastrophe losses, which represented only 2.6 percentage points of the quarterly combined ratio.
The commercial segment benefited from the lower adverse impact of the catastrophes. In Q3 2017, the commercial insurance business area reported an underwriting loss of $120 million, mainly due to the costs related to the hurricanes which hit the U.S.; in Q3 2018, the combined ratio improved by 8.5 percentage points to 97.4%.
The improvement of the underwriting margins of the commercial segment was mainly due to the lower costs of the catastrophes, which represented in Q3 2018 only 3.1 percentage points of the total combined ratio. Hence, the company reported an underwriting gain of $21 million related to its commercial segment for the third quarter of 2018. On a year-to-date basis, the underwriting income was $68 million vs. a loss of $93 million, one year ago. The improvement of the year-to-date combined ratio (a 7.4 point improvement) was mainly related to the reduction in the expense ratio and the lower catastrophe impacts. The underlying combined ratio remained flat at 60.4%.
The improvement observed in the commercial segment was as well seen at the international business area. Nonetheless, the international division continued to be unprofitable.
With a quarterly combined ratio of 103.9% and a year-to-date combined ratio of 101.8%, the international activities reported an underwriting loss of, respectively, $10 million in Q3 and $13 million for the first nine months of 2018. The results of the international branch were adversely affected by the property losses in Hardy, in spite of the efforts made on the operating costs resulting in a 1.2 point reduction of the expense ratio in Q3 2018.
Last but not least, the specialty lines reported an underwriting gain of $89 million in Q3 2018 or a $28 million drop on a year-to-year basis.
Nonetheless, the year-to-date underwriting income grew by 16% to $263 million, thanks to a positive claims trend observed during the first six months of the year. In spite of a continued improvement in the underlying loss ratio, the commercial development remained weak, as the net written premiums were flat on both quarterly and year-to-date levels. Focused on niche markets, the specialty business is the cash cow of the company. As for many niche insurers, CNA has to find the right balance between commercial development and maintaining a high level of margins. Nonetheless, I remain confident in the company’s ability to maintain its high underwriting standards.
Life Segment Income Boosted By A Favorable Claims Review
CNA Financial owns a small life insurance portfolio, which is mature, adequately reserved, well-managed and in run-off. Nonetheless, the life insurance portfolio, which includes the results of the long-term care business, continues to be profitable. In Q3 2018, the Life & Group reported a core income of $32 million, mainly resulting from a $24 million after-tax favorable claims reserve review.
A Steady Contribution Of the Investment Portfolio To Earnings
In Q3 2018, the investment portfolio returned $487 million before tax or a 4% decline. On a year-to-date basis, the pre-tax investment income dropped by 3% to $1.48 billion.
The drop observed for the third quarter of 2018 was mainly related to the lower return of the non-fixed-income portfolio.
Nonetheless, with the expected interest rate hikes, the net investment income should increase, as the largest part of the portfolio is the fixed-income one.
On the Road To $50 Per Share
In Q3 2018, the book value per share was $42.41 and declined by $2.74 per share mainly because of the adverse impact of AOCI.
Regarding the underlying risks related to the company (e.g., the fact that CNA is held mainly by Loews Corporation or the continuous expectations of the shareholders regarding the dividend growth), I would pay between 1.0 and 1.2 times the book value. In my opinion, 1.0 times the book value is a fair price. Nonetheless, with the excellent results reported for the third quarter, I guess that the investors are willing to pay 1.2 times the book value to acquire CNA’s stocks. In other words, the company would value around $50 per share.
CNA reported excellent results, mainly because of the lower catastrophe losses. However, the underlying loss ratio remained steady at the overall level, and some efforts were also made to reduce the expense ratio. Even if the international branch reported an underwriting loss, the investors should be reassured. With a year-to-date EPS of $3.29 and a year-to-date dividend per share of $2.95, the dividend continues to be safe.
In my opinion, the P&C insurer will continue to make the necessary efforts to improve its underwriting margins and please its largest shareholder, Loews, by increasing over the years its dividend. With the stock increase following the Q3 2018 results, the company will be less attractive for the dividend seekers. Nonetheless, with an implied FY2018 dividend of $3.3 per share, the 6% dividend yield could be still attractive for some investors.
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