“The following article references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.”
Financial underwriting. These two words put together are sometimes the subject of heated debate and occasionally, more than mild disagreement between Advisors and underwriters. Even usually agreeable underwriters are known to argue strenuously amongst themselves and on differing sides of a financially challenging case. Unlike medical underwriting where guidelines cover a wide and deep array of conditions and risk scenarios, financial guidelines take up much less space in most underwriting manuals, highlighting the art rather the science of decision making in those cases.
But in every case, the higher the insurance amount applied for, the more thorough the financial underwriting – with extra attention paid to the financial information provided, including the nature of the applicant’s net worth – right down to the types of investments and currencies they hold. How does cryptocurrency, not brand new but still a relative newcomer in global finance, impact financial underwriting? In this Risk Bit, we’ll touch on the topic to get a sense of whether having a bit of Bitcoin is a friendly addition to the file information or whether an excess of Ethereum turns the underwriter into a file foe.
Let’s start with the name. Currency has long been part of our day-to-day lexicon, as we buy, sell, trade using money, skills, goods and services to get by. The crypto part is another matter. Originating from the Greek work to denote something that is hidden, the combination of the two words has all the potential to scare even the most courageous among the group of risk selectors know as underwriters. It is beyond the scope here to detail the creation and structure of this new currency, so we’ll highlight the fact that encryption and decentralization are key tenets as this “new money” is added to a blockchain and computerized distribution ledger, unknown prior to 2009 (1). A throwback to a time of little or no financial regulation, rampant speculation and volatility, the added concern in the early crypto era has been its’ potential appeal as a facilitator or conduit for illegal activity. A definite non-starter for underwriting.
More recently, however, the mainstream financial world is learning that cryptocurrency and equity markets rely on a number of common conditions such as supply, demand, monetary policy and geopolitics (2). The roller-coaster volatility of cryptocurrency stocks often leads to financial news stories, but only time will tell if some are consistently able to weather economic storms with a measure of resiliency. The more astute market analysts remind us that long-term bull markets ‘correct” and weed out companies with non-sustainable price/earnings ratios, overvaluation or simple bad management. Think of the dot.com bubble burst of 2001. Then think of companies such as Amazon or eBay that not only survived 2001 but have continued to thrive since then (3).
Back to underwriting and the friend or foe approach. Financial underwriting tends to favor established enterprises with overall steady growth and demonstrated leadership, especially if those leaders are being insured. Favor is reflected in more generous valuation for insurance amount approaches, whether it is a higher capitalization of earnings or assets and longer projection periods and return rates in the consideration of long-term insurance needs. Volatility, market speculation, low regulation and highly leveraged applicants looking for a quick payday elicit a more frugal approach, the decision memo often reading ‘prefer not to participate’ or ‘can only offer a reduced sum of insurance’.
The horizon? Some insurers are considering modest amounts of cryptocurrency in the client’s asset base if there is a solid, more traditional financial background and no other concerns. The development of government mandated digital banks known more formally as CBDCs (central bank digital currency), a handful already in business and being evaluated here in Canada may help ease concerns (4). Central bank regulation may be able to allay concerns related to legitimacy and even bring a measure of competition to the current crypto market, a very underwriting friendly move. To quote a line in an old Beatles song, ‘and you know that can’t be bad’ (5).
- Pritchard, Carolyn. Cryptocurrency: The Newest Challenge to Financial Underwriting. RGA Home. April 22, 2022.
- Sharma, Rakesh. Is There a Cryptocurrency Price Correlation to the Stock Market?com. May 12, 2022.
- Folger, Jean. 5 Successful Companies That Survived the Dot-Com Bubble. Investopedia.com. August 15, 2021.
- Canadian Foreign Exchange Committee. Central Bank Digital Currency and Stablecoins. Bank of Canada. June 2021.
- Lennon, John and McCartney, Paul. She Loves You. The Beatles. 1963.
This article is provided by Know the Risk, an educational website that contains underwriting information for insurance professionals, available exclusively to Advisors affiliated with PPI (login required).
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