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2013 Life Insurance Conference 2013 Life Insurance Conference

APRIL 16, 2013

Eric Johnson Background

Harvard University, B.A. cum laude, American History

Manufacturers Hanover Trust Company

NatWest Capital Markets

CNO Fi i l G EVP d Chi f I t t Offi CNO Financial Group – EVP and Chief Investment Officer

2 non-profit boards2 non profit boards

2 teen mentoring programs

CNO Financial Group | 2013 Life Insurance Conference | April 16, 2013 2

g p g

U.S. Economic OutlookUnemployment U.S. data remains generally positive, but not

6%

8%

10%

8%

10%

12%Unemployment

Long Term Unemployment

p y

men

t

g y ppositive enough to resolve uncertainty

Expect consumer spending to slow due to lagged response to January’s tax increases, and the sequestration cuts

Positive wealth effects from stocks

Lon

2%

4%

6%

2%

4%

6%

Une

mpl

oym

Persistent inflation undershoot threatens to become globalized

Equity markets have gone very far very fast creating an environment primed for correction

ng Term

69%

0%0%

Labor Force Participation Rate Net Job Gains/Losses

QE3 outlook extremely data dependent

63%

65%

67%

69%

te ons

1 0

-0.2

0.6

1.4

57%

59%

61%

63%

Rat

Mill

ioAverage:63.71%

3 4

-2.6

-1.8

-1.0


57%

Source: Bloomberg, Bureau of Labor and Statistics, Fed

-3.4

Headline and Core CPI

U.S. Economic OutlookRetail Sales Ex. Food and Consumer Confidence

9%11%13%15%

Headline CPI

Core CPI100

120

$290

$340

$390

$Bn)

Consum

CPI

-1%1%3%5%7%

60

80

$190

$240

$290

Retail SalesC C fid

Reta

il Sa

les

($

mer C

onfidence

Core PCE

-3% Fed Target: 2%

Real GDP Growth

40$140Consumer Confidence e

2.2%

2.7%

Y (%

)

1%

0%

1%

wth

(%)

1.2%

1.7%

YOY

-3%

-2%

-1%G

row


0.7%

Source: Bloomberg, Bureau of Labor and Statistics, Fed

3%

Interest Rate OutlookU.S. Treasury Yields Rates are range bound

2%

3%

atur

ity

y

30 Yr.

g BOJ JCB purchases have potential to exert

sizeable demand effect Contained underlying U.S. inflation is the most

consistent data trend

1%

2%

Yiel

d to

Ma

10 Yr.

5Yr.

Drag from fiscal deal and sequester likely to manifest in 2Q and 3Q

Neutral on curve given recent flattening

0%

5y5y – 10y10y Curve7s 30s Curve

Fed policy has transferred risk from households and companies to investors

180

190

200

ad (b

ps)

d (b

ps)

10

18

26

34

150

160

170 Spre

a

Spre

ad

30

-22

-14

-6

2


150 -30

Source: Barclays, Bloomberg, Fed

5% Inside the Yield Curve

4%

Potential for inflation/rising rates

Return requirements Liquidity preference

3.13%3% “Belly” Rolldown return C t d

1.86%2%

Carry trade Best value

Low repo rates QE3

C t l

1%

Central swap clearing demand for collateral

0.24%

0.76%

0%


1 yr. 2 yr. 3 yr. 5 yr. 7 yr. 10 yr. 20 yr. 30 yr.

Source: Barclays

2013 YTD Broad Asset Class Total Returns

CommoditiesRates0.5% 0.4%

-0.4% -0.4%

4%

-2%

0%

2%0.2%

4%-2%0%2%

-3.3%

-6.8%-10%

-8%

-6%

-4% -3.3%-4.2%

-5.3% -5.6%

-7.9%-10%-8%-6%-4%

Credit Risk9.7%

6.5%4.4%

3.1% 2.2%0.9% 0.2%

0%3%6%9%

12%

2.5% 2.2% 1.8% 1.4% 0.8% 0.7%%

3%6%9%

12%

-3.6%-6%-3%0%

-6%-3%0%


As of 4/9/2013Source: Barclays, Bloomberg

Investment Grade CorporatesYields by Rating Limited differentiation for risk

6%

8%

10% AA Corp

A Corp

BBB Corp

y g

atur

ity

Default losses virtually irreducible High degree of price exposure to rising rates Low all in rates not favorable to spreads

E t i k i b t ti l idi ti i k

2%

4%

Yiel

d to

Ma Event risk is substantial idiosyncratic risk

Greatest beneficiary of ‘low for longer’

Generally credit spreads will remain steep as

0%

Baa Bond Yield Less S&P 500 Earnings YieldVolatility and LBO’s

ylow growth and accommodative monetary

policy limit credit risk

1%

3%

5%

7%

ld

30

40

50

400

500

600 LBO's

VIX

Cou

nt

5%

-3%

-1%

1%Yi

el

0

10

20

0

100

200

300

LBO

C

VIX


Source: Barclays, Bloomberg, Moody’s

-5%00

High Yield CorporatesYields by Rating Limited capacity for further spread tightening

20%

25%

30%

35%

BB CorpB CorpCCC Corp

atur

ity

y g p y p g g Lower quality grades disproportionately

exposed to uncertainties in economic fundamentals

Macro correlation likely to decline meaning

5%

10%

15%

20%

Yiel

d to

Ma sector/name selection will drive investment

performance Retail participation ultimately a risk factor

0%

Spreads, Default Losses, & Net Yields High Yield New Issuance

Carry plus short duration plus low volatility equals demand

$80

$100

$120

8%

12%

16%

600

800

1000Current Spread

Avg. Default Loss

Implied Net Yield

(bps

)

Defau

p , , g

n)

$20

$40

$60

0%

4%

200

400

Spre

ad (

ult Loss/Net Yiel

($Bn


$0-4%0BB B CCC

Source: Barclays, Bloomberg, Moody’s

ld

Commercial Mortgage Backed SecuritiesAAA Last Cash Flow vs AA CMBS • Continued negative net supply

100

110

120

atur

ity

g pp y• Cap rates attractive vs. fixed income with some

inflation protection• Recent increases in IO loan underwriting• Recovering CRE values leveraging down

60

70

80

90AAA

AA

Yiel

d to

Ma collateral loss expectations

• Increasing clarity on legacy collateral quality• May see increased collateral liquidation

60

DSCR and LTV Collateral Delinquency Rates

Structural call protection plus stable to positive fundamentals

68

72

76

1.8

2.0 Avg. DSCRAvg. LTV

CR 12%

16%

20%MultifamilyRetailOfficeIndustrialHotelte

60

64

1.4

1.6

DSC LTV

4%

8%

ote

Rat


561.2

Source: Amherst, CoreLogic, POINT

0%

Non-Agency RMBSLoss Adjusted Yields Negative net supply

14%

16%

18%

20%

Prime

Alt-A

j Negative net supply Focus on bonds leveraged to housing

recovery High proportion of short sales is reducing

liquidation discount Derivatives and leverage necessary to meet

6%

8%

10%

12%

Yiel

d Derivatives and leverage necessary to meet investor return targets

Positive HPA now priced into market Future of private securitization?

4%

6%

HPA, Delinquent and REO Loans Current to Delinquent Transition Rate

Extension risk pushing investors toward short duration credit

3%

4%

5%Alt-AOption ARMsPrimeSubprime

$800

$1,200

0%

10%

20% Mortgage Loans

Annual HPA

l HPA

te

Delinque

1%

2%

$0

$400

20%

-10%

0%

Ann

ual

Ratent/REO

Loans (


0%$0-20%

Source: Amherst, CoreLogic, Deutsche Bank, JP Morgan

($Bn)

AgenciesYield and Spread to Treasury • Despite very favorable technicals, lackluster

4%

6%

8%

FNCL

Basis

QE3atur

ity

p y p y ,performance due to policy and prepayment risk

• Increase in mortgage banking capacity should leverage up prepays

• Structural uncertainty – regulation, capacity, credit standards GSE’s

0%

2%

4% QE3

Yiel

d to

Ma credit standards, GSE s

• Specified high LTV, low loan balance, low FICO, seasoned collateral will continue to attract premium

-2%

Issuance and Holdings MOVE Index

Captive to changes in investor consensus on QE3 timeline

80

90

100

$1,300

$1,600

$1,900

$12

$15

$18Agency REIT Equity Issuance GSE MBS Holdings

suan

ce ($

Bn)

GSE ili

ty

50

60

70

$700

$1,000

$1,300

$3

$6

$9

REIT

Equ

ity Is

E Holdings ($Bn)

Vol

ati


40$400$0

Source: Bloomberg, Fed

Collateralized Loan ObligationsLoan Default Rates and Senior O/C Ratio • Broadening CLO investor base and growing

122

126

130

10%

12%

14%

16% Default Rates

Senior O/C Ratio

Rate

/ g g gproduct demand

• Tested structural integrity and ratings stability

• Higher FDIC risk assessments may inhibit b k d d

Senior

114

118

2%

4%

6%

8%

Def

ault

R bank demand• Reinvestment risk is the major challenge to

returns

r O/C

Ratio

110 0%

CLO New Issue Volume Second Lien & Cov-Lite Volume

Arbitrage pressured by tightening BB loan spreads relative to CLO liabilities

($Bn

)

CLO New Issue Volume Second Lien & Cov Lite Volume

4,000

5,000

6,000

7,000

$30

$40

$50Second LienCov-LiteSecond Lien SpreadCov-Lite Spread

($Bn

)

$15

$20

$25

SpreV

olum

e (

0

1,000

2,000

3,000

4,000

$0

$10

$20V

olum

e (

$0

$5

$10

ead (bps)


Source: Moody’s, S&P LCD, Intex, Wachovia Capital Markets, LLC, RBS

0$0$0

Commercial Mortgage LoansLife Industry Loan Origination and Yields

7%

8%

9%

$40

$60 $ Life Industry OriginationAverage Yield

n ($

Bn) Yield

y g• Dramatic improvement in CBD

credits – cash flows, LTV’s

• Negative long term trends in suburban office, tertiary markets,

5%

6%

%

$20Ori

gina

tion

d to Maturity

yretail sectors

• Flat to positive net absorptions, although rent growth remains soft

4%$0

CML 60+ Delinquencies

• Limited development activity

• High unemployment is a serious impediment

Hi h i t t t i t d bt

6%

8%

10%CMBS

Fannie

Freddie

CML 60 Delinquencies

e

• Higher interest rates may impact debt yield, DSCR, cap rates, hence valuations

• Continued bifurcation in market, with

0%

2%

4%Life Industry

Rate strong properties receiving lenient

terms and weaker properties lacking access to capital


0%

Source: SNL, ACLI, NAIC, MBNA, Trepp LLC

Too hot and too cold

EM CorporatesCorporate and Diversified EM • Economic growth generally disappointing

atur

ity

p

3%

4%

12%

15%

18%JPM CEMBIJPM EMBIBBB Corp CEMBI - BBB Corp

CEM

B

g g y pp gleading to somewhat higher downside risks

• Expect EM investment strategy to shift away from carry due to declining correlations

• Commodity export reliance not a credit positive

Yiel

d to

Ma

1%

2%

3%

6%

9%

BI-BBB Corp

• Persistent structural reform challenges as economies increasingly need to reconnect toward domestic demand and away from labor or commodity arbitrage

0%0%

Upgrade – Downgrade Ratios Cumulative Default Rates

Despite challenges, fundamentals support tighter spreads vs. corporates

4

5

6

7EM Corp

US Corp

8%

10%

12%

US Corp

EM Corp

o

5

7

6

Upgrade Downgrade Ratios Cumulative Default Rates

e

1

2

3

2%

4%

6%Ratio

3

2

4 Rate


0 0%

Source: Barclays, JP Morgan, Moody’s, S&P

1

MunicipalsAverage Life Industry Muni Allocation • Tax revenues growing slowly but have yet to

3%

4%

d A

sset

s

g y g g y yachieve pre-recession levels

• Total muni defaults/bankruptcies have remained very low relative to other asset classes

• California and Illinois (25% of the taxable muniindex) currently have different credit

1%

2%

% o

f Inv

este

d ) ytrajectories

• America Fast Forward Bonds, essentially BABs, would become permanent under the proposed 2014 Federal budget

0%

Munis vs. BBB Corp Municipal Budgets

Combination of rating, duration and spread difficult to replicate

Munis vs. BBB Corp

atur

ity

Municipal Budgets

)

$130

$135

$140

$175

$225

$275 State Tax Collections

Non Farm Payroll

5%

6%

7%

BBB Corp

Muni

Yiel

d to

Ma

($Bn

)

($Mm

)

$115

$120

$125

$75

$125

3%

4%


$110$25

Source: Bloomberg, Financial Filings, S&P

2%

What Will Turn the Markets?

Policy Mistake

Global Deflation

Sovereign Debt/Banking Contagion Sovereign Debt/Banking Contagion

Middle East Political Tensions

Major Trading Error

Risk Asset Bubbles

GSE Exit Mistake


GSE Exit Mistake

Credit Spreads, 1/1/2005-PresentLow High

AA Corps 4914176

A Corps 59556113

BBB Corps 770105181

g

BB Corps 1,375146330

B Corps 1,858221467

EM Corp IG 88487

181

Municipals 35943169

EM Corp HY 1,341169498

EM Corp IG 88487190

CLO 53524122

CMBS AM 1,20060320

CMBS A4 65055

Esoteric ABS 1,45015225

75

Subprime LCF 1,600140355

Prime Jumbo BIG 900100


Source: Barclays Current

Prime Jumbo BIG 900100270

Alt-A BIG 125 1,400325

10%Investible Capital Markets Matrix

CCC Corp

8%

9%

B Corp

EM HY 6%

7%

ity

CMBS AJ

CMBS CPrime BIG

Alt-A BIGSubprime BIGCLO BBB BB Corp

EM Sov.Munis4%

5%

Yiel

d to

Mat

uri

CMBS AM

CMBS D

Prime BIG

CLO A

AA CorpA Corp

BBB Corp

EM IG

Munis

2%

3%

Y

CMBS A4

CMBS AM

Prime IG

Alt-A IG

Subprime IG

CLO AAA

0%

1%

2%


0%0 1 2 3 4 5 6 7 8

Average Credit RatingAs of 4/9/2013Source: Barclays, Bloomberg

AAA AA A BBB BB B CCC CC

Life Industry ImpactsAverage Life Industry Portfolio Yields* and ROE

Reduced consumer confidence -leads to lower sales

g y

Yie

ld 12%

16%

6.5%

7.0%

7.5%Yield

ROE

R

Group life benefits negatively impacted by employment trendsPo

rtfo

lio

4%

8%

5.5%

6.0%

ROE

Pressure on annuity sales, especially fixed annuities

$14 Fixed Annuity Sales

0%5.0%

Low (re)investment rates –impact on CFT and LRT margins

$8

$10

$12

$14

ns

Potential for additional reserve requirements on top of lower earnings streams$2

$4

$6

$8

$Bn


earnings streams

*Dowling Research, sample average comprised of public companiesSource: Bloomberg, Dowling Research, JP Morgan

The Interest Rate Conundrum Market Value

Spread Compression Risk

If rates return, compression risk lessens but disintermediation may increase

If rates remain low compression risk Risk If rates remain low, compression risk materializes

Fully immunized risk – practical impossibilityAssets

Disintermediation RiskToday Liabilities

i


Falling “Low” Rates

Rising “High” Rates

“Normal” Environment

ALM Issues Today

Reinvestment assumptions

Growing the asset mix

Changing investment liquidity Changing investment liquidity

Distributable earnings – susceptible to non-continuous jumps

Setting the ‘right’ objective functions

Stakeholder communication


Product Management Issues Today

Levers Constraints

Pricing

Product Features

Competition

RegulationProduct Features

Agent Comp

Regulation

Reputation

Expense Assumptions Franchise

Crediting Rates

Sales Mix

Expense Leverage


Investment ActionsAllocation to Alternatives Allocation to Mortgage Loans

3%

4%

d A

sset

s

g g

d A

sset

s

10.0%

10.2%

1%

2%

% o

f Inv

este

d

% o

f Inv

este

d

9.6%

9.8%

0%

Allocation to Treasuries and Agencies Allocation to NAIC 2

9.4%

Allocation to Treasuries and Agencies

ed A

sset

s

Allocation to NAIC 2

sted

Ass

ets

6%

8%

10%

25%

30%

35%

% o

f Inv

este

% o

f Inv

es

0%

2%

4%

15%

20%

25%


Source: Blomberg, Financial Filings, NAIC, SNL

0% 15%

140

Investment Actions - Value of Duration

120

20 Yr. Avg.

10 Yr. Avg.

5 Yr. Avg.

80

100 Current

60Bps

20

40

03 vs. 1 5 vs. 3 7 vs. 5 10 vs. 7 30 vs. 10


Source: Barclays, Bloomberg

The benefits from extending or shortening asset durations will depend on actual asset, liability and capital structure.

Emphasize U.S. domestic sectors

Transition from macro (correlated) to micro market

Call on rate led sectors – housing, banks, insurance

Municipals

Self liquidating leverage to add return

“Rent for Liquidity”


Efficient Frontier Alternatives

U.S. Growth European Growth

Equities

Banks

p

Commodities

Utilities (Regulated)

Real Estate/REITS

Carry Trade

Credit Compression

High Yield

Retail

Healthcarep

Taxable Municipals

Floaters

Technology

CRE Suburban Office

CRE Multifamily

Insurance

RMBS

U.S. Duration/Rate Bet

Energy


M S

Esoteric ABS

Product Management Investments

Asset-Liability Management


Thank YouThank You


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