Private Ratings, Hidden Risks: How Life Insurers Are Gaming the Credit Rating System

Xuelin Li, Sangmin Oh, and Giacomo Ricciardi, authors of the June 2026 study “Rating Without Market Discipline” — deliver an empirical indictment of private credit ratings in the insurance sector. The findings deserve serious attention from anyone thinking about the systemic risks embedded in private credit markets.

What the Researchers Examined

The authors focused on the U.S. life insurance sector, which has become one of the largest holders of privately rated bonds. Their central question: are private credit ratings — those disclosed only to the issuer and select investors rather than disseminated publicly — as informative as public ratings carrying the same letter grade?

Insurance regulatory filings (NAIC Schedule D) require insurers to disclose not just what rating a bond carries, but which channel produced it: a public rating agency filing (Filing Exempt), a private letter rating, or the NAIC’s own in-house Securities Valuation Office (SVO). This rare data transparency allowed the researchers to compare bonds assigned identical credit ratings but certified through different channels — an apples-to-apples test of whether the rating channel itself matters.

The data covered 650 U.S. life insurers from 2018 through 2025, spanning more than 2.8 million bond-insurer-year observations.

The Rise of Private Ratings

Privately rated bond holdings at U.S. life insurers grew from $46 billion in 2018 to $481 billion by 2025 — a roughly ten-fold increase in seven years. As a share of total bond portfolios, private ratings rose from 1.5% to 12.2% over the same period.

The growth is being driven by the largest insurers, those with the greatest exposure to high-yield bonds, and those owned by private equity. PE-owned insurers carry private rating shares roughly 10 percentage points above the industry average.

On the supply side, the market exhibits a striking segmentation. The Big Three rating agencies — S&P, Moody’s, and Fitch — dominate public ratings, accounting for roughly 95% of all outstanding NRSRO ratings. But the private letter rating market is dominated by three smaller agencies: KBRA, DBRS Morningstar, and Egan-Jones, which collectively supply approximately 86% of life insurers’ private-letter-rating exposure. These smaller agencies have far less public market visibility, face weaker reputational discipline, and employ credit analysts with less experience and lower rates of advanced educational attainment than their Big Three counterparts — while paradoxically paying slightly higher salaries.

The Core Finding: Private Ratings Are Inflated

If public and private ratings carry equivalent information, two bonds with the same NAIC rating designation should experience similar rates of subsequent credit deterioration, regardless of how the rating was obtained. The authors measure deterioration using other-than-temporary impairments (OTTIs) — write-downs insurers must record when credit losses are no longer considered temporary. These are reviewed by auditors and represent a regulator-sanctioned proxy for realized credit losses.

· Conditional on carrying the same credit rating, privately rated bonds are approximately twice as likely to be impaired within one year as their publicly rated equivalents. The gap widens further at the two-year horizon.

· Within the same issuer — an even tighter comparison — the gap is larger still and heavily concentrated in high-yield bonds, where privately rated securities show excess impairment rates of 4 to 7 percentage points relative to publicly rated bonds from the same company.

· Applying a conservative two-notch downgrade to privately rated bonds — which the data suggest understate risk by 2.5 to 3.3 notches — would have increased required capital charges on insurers’ bond holdings by $4.5 billion per year on average from 2021 to 2025, with the cumulative five-year shortfall reaching $22.6 billion.

Stale as Well as Inflated

The problem is not just that private ratings are too generous at the point of assignment. They are also slower to adjust when credit conditions deteriorate. Privately rated bonds are downgraded less often than equally rated public bonds — about 0.5 to 0.7 percentage points less likely to be downgraded within one year, against average annual downgrade rates of 3.5%. And when privately rated bonds do impair, the losses are worse: impairment severity is 6 to 11 percentage points higher than for comparable public bonds, against an average severity of roughly 19%.

The Role of Market Discipline

What explains the gap? The authors point to the absence of market discipline. When a rating is public, bond market participants observe it, price it, and punish agencies that issue inflated assessments through reputational consequences. Private ratings receive none of this feedback. They circulate only among the issuer, the insurer, and the regulator — with no external pricing mechanism to discipline inaccurate certification.

The authors test this mechanism directly by examining the small subset of bonds that are privately rated by one insurer and publicly rated by another — so-called dual-rated bonds. When a public benchmark exists for the same security, the accuracy gap between public and private ratings disappears entirely. The private rating behaves just like the public one. This is strong evidence that it is the presence or absence of market discipline — not the underlying rating technology — that determines whether a rating accurately reflects credit risk.

Equally telling is the fact that only 1.7% to 3.4% of privately rated bonds carry a contemporaneous public rating for any insurer in any given year. The private rating market overwhelmingly operates outside the reach of public scrutiny.

Strategic Use of Private Ratings

The authors also document that insurers actively exploit the private rating channel to minimize regulatory capital. When bonds move from the NAIC’s in-house SVO channel into the private rating channel, they are upgraded more than four times as often as they are downgraded. This upgrade tendency is specific to transitions into the private channel — when the same in-house-rated bonds move to a public rating instead, upgrades and downgrades occur at roughly equal rates. The private channel delivers something the public channel does not: a more favorable — and stickier — assessment.

To establish causation rather than correlation, the authors exploit the NAIC’s 2021 capital reform, which introduced a finer schedule of risk-based capital charges mapped to 20 granular rating sub-categories. The reform mechanically increased capital charges on some portfolios while reducing them on others, depending on the precise composition of each insurer’s pre-reform holdings. Insurers facing larger mechanically induced capital charge increases tilted their portfolios more heavily toward privately rated bonds after the reform, particularly in high-yield holdings where the effect was most pronounced. The pattern holds in new purchases as well as existing holdings, confirming this is active portfolio behavior rather than passive drift. The conclusion is clear: when regulatory capital constraints tighten, insurers respond by seeking certification through the channel they correctly perceive as most lenient.

Can Regulation Substitute for Market Discipline?

The authors examine two regulatory responses — in-house credit assessment and mandatory disclosure — and find both insufficient.

The NAIC’s SVO produces more conservative ratings than either public or private channels, and downgrades more frequently. However, it is severely capacity constrained. The volume of privately rated securities the SVO must review has grown more than ten-fold since 2018 while its analyst headcount has remained essentially flat. Carry-over filings — bonds the SVO fails to complete before its year-end deadline — have tripled from roughly 800 to over 2,000 in the same period. The more rigorous alternative simply cannot be scaled to match the pace of private credit growth.

Mandatory disclosure reforms are no better. The 2020 transition to granular sub-category reporting, which increased the precision with which private ratings were disclosed to regulators, produced no statistically meaningful reduction in the private rating accuracy gap. As the authors put it, market discipline cannot be mandated into existence. It arises from decentralized investor scrutiny — from many participants observing, pricing, and reacting to a rating in a liquid market. Disclosure to regulators alone does not replicate that feedback mechanism when the underlying securities still do not trade in public markets.

Key Takeaways for Investors