In Italy, insurance companies are often encouraged to increase their direct support for the real economy, including through investments in private credit. The update to the Solvency II regulations will make it relatively easier to move in this direction. But, as is often the case, financial trends originating in the United States arrive in Italy and Europe a few years later. And the U.S. market is already showing just how much deeper—and more ambiguous—the relationship between life insurers and private credit funds can become than one might imagine.
A new report by Clearwater Analytics, covered exclusively by the Wall Street Journal, has highlighted a form of dual exposure:not only do insurers invest in private credit funds, but in many cases they also finance them directly. “About a quarter of the life insurance companies monitored by Clearwater that hold stakes in private credit funds also extend loans to those same funds,” the report states. “Typically, insurers lend the funds $2 for every dollar of shares they own.” This amounts to approximately $24 billion in loans extended to funds in which the same companies hold stakes worth about $12 billion.
The connection becomes even deeper when one considers that major private credit and private capital managers, such as Apollo Global Management and KKR, have acquired control of life insurance companies that, in turn, invest in private credit. From a certain perspective, insurance companies are nearly ideal investors for this asset class: they have long-term portfolios, predictable liabilities, collect premiums on a recurring basis, and can afford to hold illiquid instruments without having to liquidate them at the first sign of stress. In other words, they provide precisely the patient capital that private credit needs to function. For the companies, in turn, the opportunity is attractive: to increase profitability compared to traditional, predominantly bond-based portfolios.
This dual exposure—part equity and part debt—increases the capital available to private credit funds, allows for the issuance of more loans, and maximizes revenues for the insurance companies themselves, which collect both the returns on their equity stakes and the interest on loans granted to the funds. It is a profitable mechanism, at least as long as the underlying loans remain sound and the number of defaults stays low. The question emerging among analysts and regulators, however, is just how risky this indirect exposure could become in the event of a severe economic crisis and a rise in insolvencies.
Here, the issue of transparency regarding the true credit quality becomes crucial. To get a global picture of the phenomenon, it suffices to note that, according to Moody’s, insurance companies hold $807 billion in illiquid and opaque credit instruments, accounting for 20% of their $4,000 billion in bond investments. But how sound are these loans?
According to a report by the Bank for International Settlements—the so-called “central bank of central banks”—private ratings assigned to illiquid and unlisted instruments are “systematically” higher than comparable public ratings. The risk is that this greater leniency fosters a false sense of security and allows companies to reduce their capital requirements.
Complicating the picture is the fact that many ratings on private credit instruments do not come from major traditional agencies, such as Moody’s, S&P, or Fitch, but from agencies like Egan-Jones, Kroll, and Morningstar. According to research from Columbia Business School, closing the gap between public and private ratings would increase capital requirements on bonds held by insurers by $4.5 billion a year. The research, as well as a previous critical analysis by Fitch, has drawn strong reactions from Morningstar and Kroll. This back-and-forth, as the Financial Times noted, also reflects an ongoing battle to capture the lucrative private ratings market.
The assumption that some ratings on companies and private securities are automatically more favorable carries an uncomfortable consequence: in the event of difficulties, repayment capacity could prove lower than expected, and insurance companies would also bear the brunt of the impact. This, however, does not mean we should automatically draw parallels with 2008. Clearwater itself sees no signs of systemic financial risk. But the point is another: “When an insurer represents a fund’s risk capital and is also its financier, this increases the danger of cross-contamination.”
While a few isolated defaults can be absorbed without major disruption, the risk is that the accumulation of opaque exposures, generous ratings, and increasingly close ties between funds and insurers makes it harder to understand where the risk is truly concentrated. Given the current figures involved, the problem does not yet pose a systemic risk—but it is always better to recognize the mechanism and the trend before we reach that point.
