August 16, 2021
El Salvador’s recent legislation establishing bitcoin as a legal tender will likely be a credit negative for local insurance companies with exposure to the newly established currency due to higher FX and earnings volatility risk as well as additional regulatory and operating risk considerations, Fitch Ratings says.
Bitcoin’s practical implementation has yet to be defined by regulators, the announcement said. This increases the challenges using it as a store of value and means of payment, particularly given no previous or comparable usage or adoption by central banks in other global financial markets. President Nayib Bukele and congress passed a bill that will make bitcoin a legal tender, along with the USD, as of Sept. 7, 2021. All businesses must accept bitcoin as legal tender for goods or services unless they do not have access to the technology needed to process the transactions.
Fitch does not expect bitcoin to be widely used by insurers to make claim or benefit payments or insurance companies to offer policies denominated in the digital currency. The risks of using bitcoin largely relate to its rate of acceptance among policyholders. Insurers will likely convert bitcoin into USD as quickly as possible to limit exchange risks, if policyholders decide to use it to pay premiums.
The ability of insurers to minimize their holding period will depend on whether the regulatory and operational framework allows for bitcoin to be immediately converted to USD, which is not clear at this time. Insurers that hold bitcoin on their balance sheets for extended periods will be acutely exposed to its price volatility, increasing asset risk, which is a credit negative.
The government has indicated it will issue regulation by no later than Sept. 7 if the recent appeal of unconstitutionality does not modify its implementation. The regulation, while in line with the ambitious timeframe for bitcoin adoption as legal tender, appears to be unnecessarily rushed and leaves insurance companies with very little time to adapt to its requirements, creating additional risk for the industry.
El Salvador’s bitcoin regulation will need to define how the crypto currency should be accounted for on financial statements and if it will be considered eligible to back policyholder reserves. Fitch views bitcoin’s lack of transparency as a downside risk and anticipates treating bitcoin as a “risky asset” in its Risky Asset Ratio, to the extent such holdings can be identified.
Fitch generally views earnings derived from speculative activities or risky exposures such as bitcoin as a credit negative, since gains could quickly reverse, creating a volatile earnings stream. The country’s insurance sector is already exposed to low credit quality securities, mainly sovereign bonds (B-/Rating Outlook Negative) so additional holdings of high-risk assets will only compound this risk. As of YE20, sovereign and related investments represented 24% of capital and 21% of total investment portfolios of the insurance industry.
Fitch anticipates that the adoption of bitcoin will require insurance companies to absorb new IT, operating and administrative expenses. These likely will include a need to enhance internal protocols to accept payments, reinforcing the security of their systems from cyber risks and fraud and investing in advisory for the board of directors and managers, as well as training of personnel who will directly manage transactions.