A private software company gets into trouble and stops paying its lenders.
Why should someone who owns the S&P 500 care?
At first, maybe they shouldn’t.
Private credit often sits outside traditional banks and public bond markets. A PE firm buys a company, a private lender finances it, and if the company struggles, the sponsor and lender work it out privately.
But the system has become more connected.
Life insurers own private credit. Banks lend money to nonbank financial firms. Hedge funds borrow from prime brokers. Private-equity firms can own the companies making loans and the insurers buying them.
That creates a bigger question:
How can losses that begin inside opaque private markets migrate into insurers, leveraged funds, public markets, and eventually become serious enough that policymakers respond?
The answer starts with understanding who actually owns the debt.
Why life insurance suddenly matters
A life insurer may seem completely unrelated to private equity.
It isn’t.
When you buy an annuity or certain life-insurance products, you give an insurance company money today. The insurer may owe you benefits many years from now.
It doesn’t leave your money sitting in cash for 20 years.
It invests it.
That investment portfolio is called the general account.
Life insurers have traditionally owned large amounts of government bonds, high-quality corporate bonds, mortgages, and other assets that produce predictable income.
The business model is fairly simple.
If the insurer can earn more on those investments than it eventually needs to pay policyholders, operating costs, and other obligations, it keeps the difference.
Private credit fits naturally into this business because private loans often pay more than comparable publicly traded bonds.
An insurer with long-term liabilities may also be less concerned about selling every investment tomorrow.
That comes with a tradeoff.
Private assets are harder to price, harder to sell, and sometimes riskier than the traditional bonds insurers have historically relied on.
According to research cited by the Federal Reserve Bank of Chicago, private-credit investments reached roughly $849 billion, or about 14% of life-insurer balance sheets, in 2024.
Now the private-credit story has an insurance connection.
What happens when those private loans lose money?
Here is a simplified insurance company.
It owns:
- $100 billion of assets
- $92 billion of liabilities
- $8 billion of capital
That $8 billion is the cushion protecting the company if some of its investments go bad.
Now suppose $20 billion of its assets are private credit.
If those private loans fall 10% in value, the insurer loses $2 billion.
The company did not lose 10% of its entire portfolio.
But look at its capital:
Capital before the loss: $8 billion
Loss: $2 billion
Capital afterward: $6 billion
A 10% loss on one part of the portfolio just destroyed 25% of the insurer's capital cushion.
That is the part that matters.
Insurance regulation focuses heavily on the amount of capital an insurer has relative to the risks it is taking.
One measure is called risk-based capital, or RBC.
In plain English, RBC asks:
Does this insurer have enough financial cushion for the kinds of assets and liabilities sitting on its balance sheet?
A modest investment loss may simply reduce profit.
A bigger loss can push the insurer toward regulatory action levels. Regulators can demand a capital plan, restrict new business, place the company under greater supervision, or eventually take control if the problems become severe enough.
This is where slow-moving private-market losses can turn into something bigger.
Private assets can hide the problem longer
A publicly traded corporate bond has a market price.
If investors become frightened, its price may fall immediately.
Private credit works differently.
There may be no active market where thousands of investors continuously decide what a loan is worth.
Valuations can depend on models, internal estimates, private ratings, and occasional transactions.
That does not mean the numbers are fake.
It means price discovery happens more slowly.
A loan may continue looking relatively stable on paper while the economics of the borrower deteriorate underneath it.
Then something forces the issue.
The loan matures.
The company needs new financing.
The borrower asks to pay more interest with additional debt instead of cash.
The PE sponsor refuses to add more equity.
Or lenders finally restructure the company.
At that point, avoiding the loss becomes much harder.
Why private-equity-owned insurers get attention
The NAIC identified 137 private-equity-owned U.S. insurers at the end of 2024, rising to 139 by June 2025. They controlled roughly $704 billion of cash and invested assets.
That is still less than 8% of the roughly $9 trillion U.S. insurance investment pool.
But their portfolios look different.
PE-owned insurers had a larger concentration in structured securities, privately rated bonds, CLOs, and investments connected to affiliated firms than the insurance industry overall.
For example, structured and asset-backed securities made up about 29% of their bond holdings, compared with roughly 12% across the industry.
That does not mean these insurers are destined to fail. There is a legitimate business argument for the model.
A large asset manager may have expertise originating loans. Its affiliated insurer needs long-duration investments. The insurer gains access to those assets, while the asset manager gains a large pool of relatively stable capital.
The concern is the connection itself.
The same financial organization can participate on several sides of the transaction.
It can originate the credit.
Manage the asset.
Own or control the insurer buying it.
And help determine how that private asset gets valued.
That structure creates conflicts regulators have increasingly started examining.
What if a life insurer actually fails?
This is where some of the scarier claims about insurance break down.
A failed life insurer does not automatically lead to a Federal Reserve bailout.
Insurance is mainly regulated at the state level.
If an insurer gets into serious trouble, the state insurance commissioner can place it into rehabilitation and try to restore the company.
If that fails, a court can order liquidation.
State guaranty associations then protect eligible policyholders, often by continuing benefits or moving policies to another insurer.
Other solvent insurance companies in the state can be assessed to help fund the process.
Many states allow those companies to recover some of those assessments over time through lower future premium taxes.
That creates a real public-policy connection because states may eventually collect less tax revenue.
But calling this a direct taxpayer bailout goes too far.
Losses first fall on shareholders, the failed insurer's remaining assets, policyholders above guarantee limits, and other insurers through assessments.
Historically, this system has handled large life-insurer failures without a federal rescue.
The more interesting question is what happens if several large insurers get into trouble at the same time.
That is when something designed for individual failures could face a much harder test.
The refinancing wall is where hidden losses may become visible
The private-credit system also faces a large refinancing test in software.
S&P Global Market Intelligence estimates roughly $386 billion of software debt matures in 2028 and 2029.
That figure includes a broader universe of loans and bonds, so it should not be described as $386 billion of private credit alone.
The amount matters less than the mechanism.
Many software companies were bought by PE firms when interest rates were extremely low and software valuations were extremely high.
Imagine a company bought for $10 billion.
The PE sponsor contributes $4 billion.
Lenders provide $6 billion.
Then software valuations fall.
Maybe the business can now be sold for only $6 billion.
The $4 billion equity cushion has effectively disappeared.
But the company still owes $6 billion.
Now the loan comes due.
The existing lender may say:
I am not refinancing $6 billion against a company that may only be worth $6 billion unless you put in more equity.
The PE sponsor now has a choice.
Put more money into an investment that already lost billions.
Negotiate with lenders.
Or hand over the company.
We already have a major example.
Medallia shows how this works in real life
Thoma Bravo bought software company Medallia for about $6.4 billion in 2021.
The deal used billions in debt, including financing that allowed part of the interest to be paid through additional debt instead of cash.
That is called payment-in-kind, or PIK, interest.
PIK can buy time because the company does not have to send as much cash to lenders today.
But the debt keeps growing.
Eventually Medallia's annual interest burden reached roughly $300 million while annual earnings were around $200 million.
Its loans fell to about 61 cents on the dollar.
In April 2026, lenders took control through a debt-for-equity restructuring. Thoma Bravo's roughly $5 billion equity investment was wiped out, while the lenders injected fresh capital into the company.
This is private-credit stress becoming real.
But notice what did not happen.
The financial system did not collapse.
The sponsor lost its equity.
The lenders restructured the debt.
Ownership changed.
The company kept operating.
That is what a contained private-credit loss can look like.
Leverage creates a much faster problem
Private-credit losses can take years to work through.
Leverage can turn a problem into forced selling in days.
A leveraged fund uses borrowed money or derivatives to control more assets than the fund could purchase using only its own capital.
Suppose a fund has $100.
With no leverage, it invests $100.
If those investments fall 25%, the fund still has $75.
Now imagine that same $100 supports $400 of market exposure.
That is roughly 4x leverage.
A 25% loss on $400 equals $100.
The fund's entire original capital can theoretically disappear.
This is why leverage changes everything.
The investor may still believe the investment will recover.
The lender does not care.
When losses become large enough, the fund's prime broker can demand more collateral.
A prime broker is usually a major Wall Street bank that provides financing, securities lending, trading services, and other support to hedge funds.
If the fund cannot meet the collateral demand, positions get sold.
That is a margin call becoming a forced liquidation.
Situational Awareness gave us a live example
Leopold Aschenbrenner's Situational Awareness fund became one of the most dramatic examples of leveraged investing during the AI boom.
The fund reportedly grew from roughly $225 million at launch in 2024 to around $45 billion by early July 2026 after enormous gains.
It also reportedly operated with roughly four times gross leverage while concentrating heavily in AI infrastructure and semiconductor positions.
Then the trade reversed.
The portfolio fell 67% in July.
Margin calls came from its prime brokers.
The fund ultimately sold roughly $16 billion of public equities to Citadel.
But the fund survived.
It retained private investments, removed its leverage, and continued operating.
That distinction matters.
The event did not prove the long-term AI thesis wrong.
It showed that a leveraged investor can be forced to sell before there is time to find out if the thesis is right.
Why a fund may sell its good assets
This explains one of the strangest parts of financial crises.
Suppose the asset causing your problem is a private loan.
You think it is worth $80.
The only immediate buyer offers $45.
But your broker wants cash today.
Meanwhile, you own liquid stocks or government bonds with plenty of buyers.
Which assets do you sell?
Often, the good ones.
That can create this sequence:
- An illiquid asset takes a loss.
- A leveraged owner gets a margin call.
- The bad asset cannot be sold quickly.
- The owner sells liquid assets instead.
- Those prices fall.
- Other leveraged investors get margin calls.
- They start selling too.
Now a problem that began somewhere obscure is affecting public markets.
The 2022 UK pension crisis showed how quickly this can happen. Leveraged pension strategies faced collateral calls after government bond yields jumped. Funds sold liquid government bonds to raise cash. That selling pushed yields even higher, creating more collateral calls.
The Bank of England eventually stepped in with temporary bond purchases to stop the feedback loop.
When do policymakers actually care?
Policymakers do not normally rescue investors because they lost money.
They intervene when the losses threaten the functioning of the financial system.
History gives us several examples.
In 1998, highly leveraged hedge fund LTCM nearly failed. The New York Fed helped organize talks, but private banks provided the rescue capital.
In 2008, AIG's huge derivatives exposure connected it directly to major global banks. Its failure risked spreading losses throughout the banking system. The government stepped in.
In March 2020, leveraged Treasury trades unwound during the COVID panic and liquidity deteriorated in the U.S. Treasury market itself. The Fed launched massive Treasury purchases and repo operations.
And in 2022, the Bank of England temporarily bought government bonds after leveraged pension strategies created a self-reinforcing gilt-market selloff.
There is a common pattern.
The trigger is not simply a large loss.
The trigger comes when leverage and interconnectedness threaten a market the financial system needs to function.
Treasuries.
Repo.
Bank funding.
Major counterparties.
Core collateral.
That is a much higher bar.
A private-credit problem does not automatically end in money printing
This also changes the final macro argument.
The sequence is sometimes presented like this:
Private-credit losses → insurer failures → Fed intervention → money printing → stagflation.
Every arrow in that sequence depends on something else happening first.
There are at least three paths.
Path 1: Contained restructuring
More Medallia-style deals happen.
PE sponsors lose money.
Lenders take markdowns.
Some companies change ownership.
The damage stays mostly inside private markets.
No central-bank intervention is needed.
Path 2: Deflationary credit event
Defaults become broad enough that lenders pull back.
Credit spreads rise.
Refinancing becomes harder.
Companies cut hiring and investment.
Asset prices fall.
Economic growth slows.
That is initially a deflationary credit shock.
Path 3: Systemic financial stress
Losses hit enough interconnected funds, insurers, banks, or financing markets that forced selling overwhelms private buyers.
A core funding market begins malfunctioning.
Then policymakers may intervene.
Even then, stagflation is not automatic.
A temporary lending facility is very different from years of large-scale asset purchases combined with massive government spending.
For a financial rescue to later contribute to stagflation, several other conditions would likely have to exist at the same time, including persistent fiscal expansion, supply constraints, weak growth, and sustained inflation pressure.
What should we watch?
We do not need to predict which insurer or fund blows up next.
The financial system gives us signals along the way.
Watch PIK usage. More borrowers paying interest with additional debt can signal that cash flows are getting tight.
Watch private-credit non-accruals. Those show loans that have stopped producing expected interest income.
Watch BDC net asset values. Broad markdowns across several lenders would tell us private-credit losses are becoming harder to hide.
Watch insurer RBC ratios. Falling capital cushions would tell us private-credit losses are moving onto insurance balance sheets.
Watch credit spreads. A credit spread is the extra yield investors demand above comparable Treasury bonds. Rapid widening tells us lenders are demanding more compensation for risk.
Watch hedge-fund leverage and prime-broker margin requirements. Rising leverage makes the system more sensitive to relatively small price moves.
And watch repo and Treasury-market stress.
That is where the story changes.
A PE sponsor losing billions is painful.
A hedge fund getting liquidated can be spectacular.
But when funding markets and core collateral stop working properly, the problem has moved into a different category.
That is when private losses stop being private.