According to Financial Times News, UBS chair Colm Kelleher warned at the Hong Kong Monetary Authority’s Global Financial Leaders’ Investment Summit that insurers are creating a “looming systemic risk” through “ratings arbitrage” on private credit assets, drawing direct parallels to pre-2008 subprime lending practices. Kelleher specifically criticized smaller rating agencies providing “private letter ratings” that are typically only visible to issuers and select investors, while US life insurers have emerged as major buyers of such debt. The Bank for International Settlements last month echoed concerns that ratings on private credit assets held by US insurers might be inflated, warning of potential fire sales during financial stress. Recent bankruptcies of subprime automotive lender Tricolor and car parts company First Brands have intensified scrutiny of the industry’s opacity. This warning from one of finance’s most experienced leaders demands deeper analysis of the systemic vulnerabilities building beneath the surface.
Sponsored content — provided for informational and promotional purposes.
The Dangerous Return of Ratings Arbitrage
What Kelleher describes as “ratings arbitrage” represents a fundamental breakdown in market discipline that should concern every investor. The emergence of specialized rating agencies catering specifically to private credit issuers creates an inherent conflict of interest that mirrors exactly what we saw with mortgage-backed securities before 2008. When rating agencies compete for business by offering more favorable assessments, the entire ratings system becomes compromised. The Bank for International Settlements has correctly identified the inflation risk, but the problem runs deeper than just optimistic valuations. These private letter ratings effectively create a two-tier disclosure system where sophisticated institutional investors see one reality while regulators and the broader market operate in the dark.
Why Insurance Companies Are Particularly Vulnerable
The insurance industry’s massive private credit exposure creates a perfect storm of regulatory gaps and structural vulnerabilities. Insurance companies operate with long-term liabilities that demand stable, predictable returns, making higher-yielding private credit assets particularly attractive in today’s low-yield environment. However, the fundamental mismatch between insurers’ need for liquidity to meet policyholder claims and private credit’s inherent illiquidity creates a ticking time bomb. When market stress emerges, as it inevitably will, insurers may be forced to sell these illiquid assets at fire-sale prices, potentially triggering a downward spiral that could spread throughout the financial system. The Federal Reserve and state insurance commissioners have been slow to recognize this emerging threat, focusing instead on traditional banking sector risks.
The Domino Effect Nobody’s Discussing
The systemic risk extends far beyond the insurance sector itself. Private credit has grown to become a $1.7 trillion market, with insurance companies representing one of the largest investor classes. A significant repricing event in private credit would immediately impact pension funds, endowments, and retail investors through various investment vehicles. More concerning is the potential for contagion to the broader corporate lending market, as many middle-market companies now rely exclusively on private credit for financing. If this funding source suddenly contracts or becomes prohibitively expensive, we could see widespread corporate distress that spills over into employment, consumer spending, and economic growth. The interconnectedness of modern finance means that problems in one corner rarely remain contained.
The Regulatory Blind Spot
Perhaps most alarming is the regulatory gap Kelleher highlights. Insurance regulation operates primarily at the state level in the US, creating a fragmented oversight system ill-equipped to monitor systemic risks. The National Association of Insurance Commissioners lacks the authority and resources to coordinate a national response to emerging threats in private credit markets. Meanwhile, banking regulators remain focused on traditional banking activities, viewing insurance as someone else’s problem. This regulatory vacuum has allowed the private credit market to evolve without adequate supervision, transparency requirements, or stress testing. The situation echoes the pre-2008 environment where regulators failed to recognize how mortgage-backed securities distributed risk throughout the system.
2008 Redux: What’s Different This Time
While the parallels to 2008 are striking, there are important differences that could make the current situation even more dangerous. The private credit market operates with even less transparency than the mortgage-backed security market did before the financial crisis. Private letter ratings and limited disclosure mean that even sophisticated investors have incomplete information about the true quality of underlying assets. Additionally, the rise of direct lending means that many of these loans never see the light of public markets, making it difficult to establish market-based pricing. The concentration of risk in the insurance sector—traditionally viewed as a stable, conservative industry—could amplify the shock when reality eventually contradicts optimistic assumptions.
The Urgent Need for Action
The solution requires coordinated regulatory action before a crisis forces our hand. Regulators must immediately demand greater transparency in private credit investments, including standardized disclosure requirements and independent third-party valuation. The SEC should scrutinize private letter ratings to ensure they meet the same standards as public ratings. Most importantly, insurance regulators need to implement robust stress testing that accounts for the liquidity mismatch between private credit assets and policyholder liabilities. The time for warnings has passed; what we need now is preventative action to defuse this building threat before it triggers the next financial crisis.
