Insurers and private credit: Ratings under the microscope

Private credit ratings have hit the headlines in recent months, amid increasing allocations from insurers. Aysha Gilmore investigates the risks behind the ratings…

Over the past month, an increasingly vocal chorus in the mainstream media and parts of the banking industry has been calling out the “risks” tied to insurers ramping up their allocations to private credit.

The criticism comes from two angles, often tangled together. First, that insurers’ growing commitments to private credit may be too risky due to transparency and illiquidity issues. Second, that the surge in smaller private credit ratings agencies might be understating true credit risk for the industry, with not all of them being trusted equally.

Read more: Fitch warns of “transmission risks” as European private credit market scales

Throughout the past month headlines have taken aim at insurers’ private-credit exposure alongside ratings agencies. Colm Kelleher, chair of UBS, has accused insurers of ratings shopping and labelled the trend a “looming systemic risk”. Over in the UK, Bank of England Governor Andrew Bailey has also expressed doubts about the role of the rating agencies, following stating that “alarm bells are starting to go off”.

Yet, at the same time, reports suggest insurers are preparing to increase allocations to the sector. Moody’s reported back in June that US insurers have increased their commitments to private credit to one-third of the sector’s $6tn (£4.4tn) in assets. The same is happening in Europe, with insurers growing their private credit holdings to around four per cent in 2024. So what exactly is going on, and why has this attracted so much attention?

In the limelight

One key point behind insurers being thrust into the limelight is the simple fact that they rely on credit ratings. With risk “front and foremost” for insurers, Nuwan Goonetilleke, head of capital markets at UK-based insurance company Phoenix Group told Alternative Credit Investor that ratings translate risk into “a nice letter”, helping them slot assets into capital and risk models.

Much of the media focus has landed on US insurers, partly because the US lacks a single supervisory regime, as each state runs its own regulation. Even so, the National Association of Insurance Commissioners (NAIC) acts as the central body for standard setting, regulatory support and consumer protection for insurers. Additionally, some of the attention is directed to segments of the private credit market that are particularly popular with US insurers.

One likely trigger for the recent scrutiny is the NAIC’s review of potential rating-inflation in private credit. It found inconsistencies across the market, especially between the average ratings given by different agencies, it highlighted in a statement.

At the same time, the ratings market, once dominated almost entirely by Moody’s, S&P and Fitch, has been joined by a clutch of smaller players in the privately rated space: Egan-Jones Ratings Company, HR Ratings, KBRA and Morningstar DBRS among them.

‘Cherry picking’

A big narrative circulating is that the rise of smaller agencies reflects insurance companies ‘cherry picking their rating’. But industry professionals have argued that the growth is more structural. The private credit market has expanded dramatically in recent years, doubling from around $1.53tn in 2023 to $3tn. Therefore, with more credit offerings comes more ratings. Alongside this, the demand for ratings has increased as the demand for alternatives has risen.

Stephanie Thomes, senior investment consultant at Mercer USA, told ACI that not all agencies specialise across every corner of private credit. “Consequently, smaller agencies are willing to take on credit niches that the larger firms can’t or won’t accommodate until there’s significant demand or scale,” she said.

Insurers themselves say the ‘big three’ still dominate. In the UK, Phoenix, which has £15bn to £20bn in private markets overall, said smaller agencies represent just a “fraction of the number”.

“The increasing use of other agencies is equally important, we understand that some of the ‘big three’ agencies don’t have the capabilities in all of the things that you need for private markets,” said Goonetilleke. “They don’t have the methodology that covers every sector. So, we do use some of the other agencies, and we do have our own capabilities, which are regulated.”

Ratings also differ because US insurers operate under the NAIC standards, while UK insurers fall under Solvency II. But with much of private credit originating from US asset managers, UK insurers still keep a close watch on US developments.

Goonetilleke notes that the concern around ratings agencies in the US is largely due to asset-backed private credit. This has only intensified after the collapse of auto-lender Tricolor, tied to asset-backed securitisations involving subprime auto loans, sparking questions about insurer exposure to such deals.

Although KBRA placed Tricolor on watch downgrade before the collapse, the case has fed into broader concerns that private-credit ratings may be “systemically inflated”.

“We have an eye [on the US] and we are watching for the trends, we just don’t invest in those deals [asset-backed securities] that come along that don’t fit in our criteria,” Goonetilleke added, noting that Phoenix primarily invests in direct lending. “So, it comes down to your risk appetite as a group and how you maintain that risk.”

Systemic risk

For critics such as Kelleher, the bigger issue is structural: the lack of regulation for US insurers, combined with a “massive growth in small rating agencies ticking the box for compliance”, is creating “systemic risk”.

So, could ratings themselves, if flawed, pose a systemic threat to the industry? Industry stakeholders say that when insurers commit capital to a private credit fund, the decision sits with the insurer to decide if the rating is valid. Many also run their own internal risk assessments.

Read more: ‘Cockroach’ fears overblown after Tricolor and First Brands fallout

Ashish Dafria, chief investment officer at UK Insurance company Aviva, told ACI: “On ratings agencies, they play an important role in the investment chain, particularly for regulatory purposes. Our approach does not rely solely on external ratings however, and we operate a robust, independent risk management framework to assess and manage credit risk across all asset classes.”

While in the US, Thomes adds that regulatory scrutiny of private-letter ratings is prompting some managers to mitigate risks by obtaining “dual ratings” from the nationally-recognised statistical rating organisation.

From the manager side, Brett Lousararian, head of global insurance group at SLC Management told ACI that due to the high level of scrutiny, some insurers simply will not use smaller agencies, preferring the larger names.

Rating perspective

Ratings agencies themselves also scrutinise insurers’ investment portfolios. When S&P rates an insurer, if it is not comfortable with a particular rating from another agency, it does not accept whichever ratings sits in the portfolio, it overlays its own assessment.

“Under the methodology, if there is a certain amount of bonds which sit in the portfolio of the insurance company we are rating, if we need to do additional analysis on our own to assess the risk, we are able to do that,” said Carmi Margalit, S&P’s life insurance sector lead for North American financial services ratings. “We always make sure we are comfortable with the risk assessment of the investment portfolio regardless of who rated it.”

Alongside this, S&P notes that for US life insurers, private credit bonds represent “roughly six per cent of the investment portfolio. This is not a major part of the investment portfolio of insurers”. The exposure is growing, but not “overwhelming”.

Margalit pointed out that insurers have been participating in direct lending for at least “three decades”. From a credit risk perspective, he said, private credit “is not materially different from any other sort of bond investments that life insurers in the US have been doing… there is no additional credit risk fundamentally to a single-A rated bond versus a single-A rated private placement.”

However, private credit can bring a lack of transparency, although that does not necessarily mean greater risk, he states.

“Lack of transparency simply means lack of transparency; you simply don’t know,” he added. “Some people may feel uncomfortable with the lack of transparency. Due to the position we are in, we can address the lack of transparency by asking the insurer for more information. Some people who aren’t in that position may not be able to pick up the phone and get the same answer as a lot of this information is not public.”

Asked whether regulation itself may be insufficient, Margalit cautioned against sweeping conclusions on ‘systemic risk’: “I don’t think I can make a broad statement that regulation is insufficient… It is never as simple as saying any one statement, there is always more complexity once someone starts analysing.”

Tailwinds and overstepping?

Perhaps this is what is happening in the ratings debate today. A simple narrative is being pushed: more small agencies = cherry-picked ratings = systemic risk, but in reality, the picture is more nuanced.

Whenever markets enjoy long, favourable tailwinds, stories about looming risks naturally start to pile up. High-profile collapses in the leveraged loan or private-credit ecosystem make the narrative even more compelling. Throw in claims that smaller agencies offer inflated ratings, and the fire spreads quickly.

Read more: S&P Global: Insurers are managing private credit risks well

None of this means the conversation is unhelpful. If certain agencies have “overstepped”, that is worth examining. Speaking to those in the sector, Egan-Jones is under the spotlight more than most and some believe that the scrutiny towards them may be warranted.

Responding to criticism about systemic risk and inflated ratings in private credit, Egan-Jones told ACI that its private debt defaults are “far lower than expected” in its ratings and its accuracy has been independently validated. The firm added that its 2024 public ratings were within 0.19 notches of a major agency across more than 1,100 issuers and said it uses the same methodology for public and private ratings, noting: “We stand behind our record.”

However, most participants in the sector say they still rely primarily on the major ratings agencies, with insurance companies conducting their own due diligence and issuing corresponding ratings. Furthermore, considering that private credit still represents only a small share of allocations, this questions whether “systemic risk” concerns are as significant as some people suggest.

Recently, Marc Rowan, chief executive at Apollo, pushed back on Kelleher’s warning about systemic risk in private credit ratings for the insurance sector. For Apollo-backed insurer Athene, 70 per cent of assets are rated by major agencies like S&P, Moody’s, and Fitch. Rowan acknowledged that Kelleher was “not wrong” to raise concerns about systemic risk but emphasised that the issue was not the ratings agencies.

Overall, this debate should not overshadow the fact that private credit has a “natural home” within insurers’ portfolios, as Lousararian told ACI. However, we could do with a broader discussion around the current ratings drama.