The document discusses the evolution of investment issues leading up to and following the 2008 financial crisis, highlighting the risks associated with sub-prime mortgages and structured products. It emphasizes the importance of a consistent investment process and risk management amidst ongoing economic uncertainties. Additionally, it raises concerns about unrealistic trust in rating agencies and the potential impacts of regulatory and accounting changes on investment strategies.

1. Getting a Grip on Key Investment IssuesAlton R Cogert, CFA, CPA, CAIAPresident and Chief Executive OfficerExcerpted from presentation toThe Conference for Risk Retention PoolsOrganized by Aon Global Risk ConsultingLa Jolla, CAAugust 4, 2009

2. Getting a Grip on Key Investment IssuesToday’s Investment EnvironmentYour Pool’s Investment ProcessWhat to Watch For in the Near Future2

3. Not Very Long Ago…Prior to 2008Interest rates fell – lower yields for risk free securitiesSpreads narrowed – less compensation for credit risk & prepayment risksHousing prices had been risingInvestorsReached for yield, took more risk, with less compensationFound “attractive” yield in sub-prime mortgagesInvestment BanksCreated new structure to create more yield with leverage and less transparencyPackaged sub-prime mortgages & utilized those securities within their structured vehicles to provide more yieldRating agenciesAccommodated by giving higher ratings in structures where the risks were not fully understood3

4. How did this turn into a crisis?In 2008, when interest rates started to riseSub-prime mortgages increased defaultStructured products unraveledLeveraged financial institutions brought close to collapseLehman bankruptcy seized credit markets – trading haltedCredit problems extended into a global markets crisisDeveloped into deepest recession since the Great Depression“Spread-products” (corporate bonds, mortgage-backed bonds, and structured products) underperformed risk-free (Treasury) bonds as spreads widened through March of 20092nd quarter 2009 spreads narrowed & corporate bonds recoveredYet, defaults and bankruptcies increasedDefaults increased in sub-prime mortgagesSome structured products (backed by sub-prime & defaulted bonds) have not recovered4

5. And Today…Spreads still historically above averages, but what average should be used?US Government spending like drunken sailors…but is it enough?Unusually steep ‘risk free’ US Treasury yield curve…but how risk free is it?Concerns about inflation….and deflation.Equities – too high or the deal of the decade?Rating agencies…on the prowl, trying to justify their improper business model. Few have 100% trust in rating agencies, but no investment policy excludes ratings from their list of limits.Regulators…accommodative (fair value, ‘permitted practices’) but still concerned about some insurers.Accountants…the politicization FASB potentially means anything can be ‘up for grabs’.5

6. History of 5-year Treasury Note Yields – Yield changes over time6

7. History of Yield Curves – Yields on 2 and 10-year US Treasuries – changing shape of the curve7

8. Deutsche Bank Indices of yield spreads for BBB (blue) A (yellow), and AA (red) rated bonds8

9. Your Pool’s Investment Process9Consistent Investment Results REQUIRE aConsistent Investment Process

10. 10What to Watch For in the Near FutureGreater Emphasis on Risk Management, because Uncertainty Will Grow not Subside Over TimeLook for hidden risk. It’s there, but not being discussed to any great degree.