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Hedge fund guru Paulson cashes in on CNO wager

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John Paulson, who made $15 billion betting against real estate and then saw his fortune shrink as gold slumped, is proving to be an effective insurance investor.

Paulson’s hedge fund has more than doubled its money on Carmel-based CNO Financial Group Inc., the life insurer he helped recapitalize in 2009. Paulson & Co. can realize more gains when warrants it received become exercisable this month at about half CNO’s current share price.

The billionaire’s remarks on insurers like Radian Group Inc. and Hartford Financial Services Group Inc. jolted the stocks even after his fortune diminished with wrong-way bets on a U.S. economic recovery in 2011 and a worsening European debt crisis in 2012. The CNO and Radian wagers helped prop up firms that had been seen by the bond market as vulnerable to failure.

The fund “took a lot of risk and reaped a lot of reward” on CNO, said Randy Binner, an analyst at FBR Capital Markets. “To say they saved the company is fair.”

Shares dipped below 30 cents in 2009 as the insurer struggled with losses and debt. CNO surged 153 percent since Oct. 13, 2009, when Paulson’s investment was announced, better than all 22 companies in the Standard & Poor’s 500 Insurance Index.

Its comeback to $12.64 per share Tuesday helped make Paulson’s Recovery Fund the best performer of his strategies this year, with a 28-percent gain through May.

Radian jumped 6.2 percent, to $10.69, on April 19 after Paulson, 57, wrote that shares could rise to $20 by 2015. The fund bought Radian stock at the end of 2012 and this year for $6 to $8 a share, according to a letter to investors that outlined first-quarter results and was provided to Bloomberg News. The insurer closed Tuesday at $11.37.

Paulson also bought bonds of Radian and MGIC Investment Corp., according to data compiled by Bloomberg. The companies back home loans and are part of a bet on the U.S. housing market.

Genworth Financial Inc., which offers mortgage guarantees and life insurance, is another Paulson holding, acquired at an average of $7.67 a share, according to the letter. The company closed at $10.88 Tuesday.

Paulson invested about $300 million in convertible debt and a 9.9 percent equity stake in CNO in 2009 as the insurer faced a debt maturity. The hedge fund also received warrants to buy 5 million shares of common stock at $6.50 apiece. The insurer earlier that year made a deal with lenders to relax covenants.

“Paulson was an important part of a several-part solution to helping us to navigate through the financial crisis,” CNO CEO Ed Bonach, 59, said. “We knew we had a lot more potential in front of us, and still believe that.”

Bonach was finance chief in 2009, when the insurer was known as Conseco Inc.

Talks with Paulson began in August 2009 and were led by Charles Murphy, a partner at Paulson who helps pick insurance investments, Bonach said. He and Jim Prieur, then the CEO, led negotiations for CNO.

“It wasn’t a fast-money play,” Bonach said. “It wasn’t like, ‘OK, get in and let’s get out as quickly as we can.’”

CNO repurchased Paulson’s $200 million convertible debt investment last year for $355 million. Paulson began scaling back the stake in CNO in the third quarter of 2011, and held about 13.5 million shares, not including the warrants, as of March 31, according to data compiled by Bloomberg.

“We provided needed capital to CNO during a crucial time,” Murphy said in an emailed statement. “We remain a large shareholder and are supportive of their ongoing turnaround.”

CNO is working to increase return on equity to 9 percent by 2015 from 6 percent in 2012 and to move its credit rating toward investment grade. S&P lifted the score to BB- in May, the third- highest level of junk status, citing rising earnings. It had sunk as low as CCC during the crisis.

Bonach’s strategy is to focus on sales to middle-income individuals, typically around retirement age. The firm offers long-term care policies, life insurance, annuities and health coverage that supplements Medicare, the U.S. health program for the elderly and disabled.

Murphy, who previously worked at Morgan Stanley and Deutsche Bank AG, was on the board of CNO from 2010 through 2012. The insurer also agreed to $25 million with Paulson.

The rally in insurance stocks contrasts with Paulson’s investment in gold, which had tumbled about 24 percent this year through yesterday. Paulson had bet that efforts by policymakers to stoke economic growth could fuel inflation, increasing the metal’s value.

Betting on macroeconomic trends “has been a very difficult business since 2008 because of the major intervention of central banks,” said Donald Steinbrugge, managing partner at hedge-fund consulting firm Agecroft Partners LLC. “It is very difficult for someone to predict what the government is going to do.”

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