Photo by Juan Pablo
A new paper making a stir in the financial press spells out the dangers to which private equity-owned life insurance companies are exposed by private credit funds with large portfolios of loans to software and AI companies. It’s a complicated story that could have enormous consequences.
Pranjal Drall and Andrew Granato, the report’s authors, argue that some of these insurance companies could become insolvent if these loans crash. And an unanticipated consequence of a 60-year-old rule that protects insurance company policy holders from losing all of their life insurance benefits or annuity payments could leave taxpayers holding the bag.
Let’s step back to understand some of the backstory. In 2022, I wrote about private equity firms gobbling up life insurance companies, and in 2026 about the risky, high-fee investments these companies were making with people’s life insurance and annuity premiums. Private equity firms are best known for the private equity (PE) buyout funds they sponsor. These funds buy up anything from doctor’s practices to single-family homes to youth sports leagues. PE funds use money committed by their investors as the down payment (the equity) on these acquisitions, and they use lots of debt to acquire companies in what are known as leveraged buyouts (LBOs).
As PE firms diversify their holdings, life and annuity insurance companies are an attractive target because they amass premium income, but may not need to pay out benefits for years or even decades. PE’s interest in owning life insurance companies emerged in earnest in 2009 following the Great Financial Crisis, and accelerated in the early 2020s.
While traditional insurance companies mostly invested premium income in corporate and Treasury bonds, PE firms count on earning high fees for managing risky investments made with these assets, and on profiting from the spread between what it owes policyholders and what its investments earn. There are no legal barriers to private equity-owned insurance companies using their assets to support struggling companies also owned by their PE owner, and no prohibition on selling poorly performing loans of a PE-owned company to an insurance company owned by the same PE firm. PE-owned life insurers also extract value by transferring assets and liabilities to a shadow reinsurer it owns or is affiliated with. This can reduce the insurance company’s tax liabilities, lower its capital requirements and hide the extent of the risk it is exposed to.
Private Credit Funds Make Big Bets on Software and Data Centers
Stricter financial regulations put in place following the Great Financial Crisis were intended to prevent similar catastrophes in the future. The regulations limited the amount of debt that regulated financial institutions could put on a company, crimping the ability of PE funds to use as much debt in LBOs as they wanted. Banks were restricted from making riskier loans, and this resulted in small- and medium-sized companies finding it difficult to get bank financing. Immediately, private equity firms stepped into the breach and created private credit funds to make direct loans to companies frozen out of public financial markets Private credit funds are sponsored by investment firms, including PE firms. They are not subject to the regulations intended to make the financial system safer. They operate in the shadows, making risky loans to companies, many of whom don’t qualify for bank loans. Today, private credit funds hold $3 trillion in largely unregulated, high risk, opaque loans — many made to companies owned by PE firms.
Private credit funds have been a hot investment for the last 16 or so years. These loans are not subject to the rules that govern corporate bonds. Because the loans are risky, lenders demand a premium and borrowers pay high interest rates — a profitable situation that rewards investors in these funds. The funds have bet big on software firms that create code and develop management tools that businesses subscribe to, providing them with multi-billion-dollar loans. The software tools manage various business operations — customer relationships, workflow and corporate spending — and are collectively known as Software as a Service (SaaS). Private credit funds are also behind the multi-billion-dollar loans to the huge data centers that AI firms are building to train their latest AI models.
Where do these billions of dollars come from? While there are multiple sources of funding for private credit funds — including investment banks like Goldman Sachs that are barred from making these loans directly, and pension funds looking for lucrative payoffs — private equity-owned insurance companies figure prominently as a source of capital for these funds. Investments in SaaS have been the bread and butter of private credit funds. The recurring income these companies generate from business subscribers have enabled them to make payments on their massive loans; default rates have been low.
But share prices of these software companies cratered in 2026 under pressure from Claude, AI company Anthropic’s code-writing frontier model and other similar models. As a whole, these AI tools are undermining the SaaS business model and challenging the “assumptions around software growth, pricing power and borrower durability.“ Investors in private credit funds worry that many of the SaaS companies will not be able to repay their loans.
Similar doubts are being raised about the construction of super expensive data centers that private credit funds are financing amid rising concerns about an AI bubble and anxiety about what will happen if the bubble bursts. Will many of the data centers become white elephants, deserted by the AI firms that planned to use them to develop new AI models? Will the return on investment in models trained in these expensive data centers justify business spending on these high-cost AI models? Will the much cheaper Chinese AI models out compete the US models and take market share away from American AI companies? These questions are raising doubts about whether all of these loans can be repaid. And if the loans can’t be repaid, what then?
Insurance Regulations Could Bail Out Risky PE Bets
PE-owned life insurance companies will see their investments in private credit funds crushed, marked down substantially or even wiped out. Private credit default rates above 15 percent may lead some insurance companies to become insolvent and unable to make good on the life insurance payouts or annuity payments promised to beneficiaries.
At that point, state Insurance Commissioners will step in. Rules put in place decades ago to protect beneficiaries of insurance companies enable the commissioners to require the remaining life insurance companies in the state to pay into a special guaranty fund that will make good on the policies held by the beneficiaries of the defunct company, up to a cap of about $300,000 on life insurance and about $250,000 on an annuity. That varies by state. Insurance companies not affiliated with a PE firm and that didn’t make risky bets on private credit will be required to bail out the failed insurance companies that did. And the PE firm that owned the insolvent company will get off scot-free and not have to pay anything. That creates a moral hazard and seems to be a miscarriage of justice.
But the story doesn’t end there. In 44 states, these payments are fully creditable over five years against state taxes on premium income. That means that, ultimately, it is taxpayers in those states that provide the backstop when software and/or AI companies can’t repay their loans to private credit funds, and a private equity-owned insurance company that invested in private credit funds becomes insolvent. The result is, as the report’s authors point out, “a system that socializes losses.”
First published by CEPR.
