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Credit ratings on private loans held by US insurers may have been systematically inflated, the Bank for International Settlements has warned in a new paper on the growing risk of “fire sales” during periods of financial turmoil.
Ratings on private credit investments have come under scrutiny following a rise in insolvencies and recent high-profile bankruptcies at car parts maker First Brands and auto lender Tricolor. The rapid collapse of the two businesses has rattled credit markets, with some investors highlighting concerns over their complex funding structures.
Smaller rating agencies have captured market share in the fast-growing world of private credit by providing so-called private letter ratings, which are typically only visible to an issuer and select investors. US life insurers have been among the biggest buyers of such debt.
The number of insurance securities rated by Moody’s, S&P and Fitch, the big three rating agencies, has been largely flat in recent years, while the quantity rated by smaller providers has grown rapidly.
Smaller groups may face commercial pressure to assign more favourable scores, according to the BIS, which said the strategy could “lead to inflated assessments of creditworthiness” and “obscure the true risk of complex assets”.
Insurers with links to private equity groups have been heavy users of private letter ratings. About a quarter of those insurers’ investments relied on such ratings as of 2024, the BIS said.
The lack of transparency and liquidity of private loans makes them tricky to value accurately, increasing the risk of “fire sales which can amplify price movements during periods of economic stress”, the BIS added.
The BIS, which advises the world’s central banks, is the latest body to raise concerns over private credit ratings. Bank of England governor Andrew Bailey last week warned that recent troubles in the sector had set off “alarm bells,” adding that the role of rating agencies deserved more scrutiny. Some Tricolor debt had received triple-A ratings months before the lender’s collapse.
The National Association of Insurance Commissioners, a standard-setting body for US insurance regulators, earlier this year published a report finding that designations based on private ratings were on average 2.7 notches higher than its own assessments of creditworthiness. Ratings from small providers were on average 3 notches higher, it said, while those by larger groups were 1.9 notches higher.
The NAIC report, which prompted concerns that insurers could be shopping for more lenient ratings, was subsequently removed from the NAIC’s website.
An analysis by Absolute Strategy Research found that US life insurers would need an additional $30bn to $35bn of capital to maintain their regulatory buffers, if private letter ratings were moved in line with the NAIC’s designations.
Critics have also argued that private ratings are inherently less robust since they are not subjected to scrutiny by market participants.
“If market users are part of the mechanism for keeping rating agencies honest, it’s not working,” Ann Rutledge, a former senior Moody’s analyst and now chief executive of rating agency CreditSpectrum, told the Financial Times. “For the market to establish whether the ratings are reliable, they need to actually have access to the ratings.”
Reliance on private ratings is just one example of the broader financial stability risks building up in the life insurance sector, according to the BIS.
The BIS paper also describes insurers’ broader push into riskier and more complex investments, rising liquidity risks for insurers with large exposures to the US dollar, and the potential for conflicts of interest at insurers with links to private equity firms.
Private equity’s growing stake in insurance through direct acquisitions of insurers or management of their assets, may have raised “systemic vulnerabilities” in the sector, the BIS said.
Insurers affiliated with alternative investment managers invest about 24 per cent of their portfolios to private credit, as well as riskier and more complex assets, compared with 6 per cent at non-affiliated insurers, Fitch said in a note on Friday.
