Taking the High Road with Property and Casualty Cannabis Insurance

Taking the High Road with Property and Casualty Cannabis Insurance

Taking the High Road with Property and Casualty Cannabis Insurance

The rapid expansion of the cannabis industry gains more momentum year after year. Although still illegal at the federal level, a green wave is rolling across America fueled by legalization measures, reports of massive sales and record-setting tax revenue, and eager entrepreneurs and investors. 

Public support for cannabis reached an all-time high in 2017 with 64% of U.S. adults, including majorities from both major political parties, approving of cannabis use. This growing public sentiment is evident in the industry's 2017 retail sales of nearly $10 billion (combined medical and adult-use), amounting to an increase of over 30% from 2016. Estimates vary by source, but the U.S. market is expected to double by 2022, reaching somewhere between $18 billion and $22 billion in retail sales. And these numbers do not even begin to account for the rise of commercial-grade hemp manufacturing and products.

It is becoming clear that the cannabis industry is quickly outgrowing its taboo market status and that cannabis insurance must evolve and expand with it. Nevertheless, many admitted carriers still remain hesitant to consider cannabis coverage based on 

The Demotech Difference    Summer 2018preexisting prejudices, myths, and inaccurate assumptions. This article aims to shed some much-needed light on the cannabis market, providing an overview of the who, what, when, where, why, and how of property and casualty insurance for the thriving cannabis industry.

The United States of Marijuana

The cannabis industry operates on an intrastate basis. To date, 29 states (30 if you include Louisiana's limited protections), the District of Columbia, Guam, and Puerto Rico permit some level of cannabis possession and use. Nine states and the District of Columbia have legalized adult use (or recreational) cannabis, and more will certainly follow. As many as fifteen additional states may host cannabis ballot initiatives or legislative actions later this year. 

The list of adult-use, recreational cannabis jurisdictions currently includes Alaska, California, Colorado, Maine, Massachusetts, Nevada, Oregon, Vermont, Washington, and the District of Columbia. The state of Vermont is the most recent addition to the list, with legalization being signed into law this past January. The state of California, however, is perhaps the most notable new addition and well on track to become the largest combined cannabis market in the world. California's recreational cannabis regulations went live on January 1, 2018, and the state is already establishing its place as an industry leader in terms of robust regulations and market growth. 

Not to be discounted, both Colorado and Nevada boasted remarkable cannabis sales in 2017. Last July, Nevada's governor issued a state of emergency when several dispensaries ran out of cannabis in their first weeks of operation. By the end of the month, Nevada tallied over $27 million in sales. On the other hand, $100 million in monthly sales is apparently nothing new for Colorado. The states of Washington and Oregon are not far behind, however, and a potentially lucrative adult-use market in Massachusetts is anticipated to begin sales in July. 

In addition to the 10 adult-use jurisdictions noted above, medical-only cannabis has been legalized to some extent in 23 states and territories: Arizona; Arkansas; Connecticut; Delaware; Florida; Guam; Hawaii; Illinois; Louisiana (with caveats); Maryland; Michigan; Minnesota; Montana; New Hampshire; New Jersey; New Mexico; New York; North Dakota; Ohio; Pennsylvania; Puerto Rico; Rhode Island; and West Virginia. Of these, several appear poised to make the leap to adult-use later this year. For example, New Jersey Governor Phil Murphy promised during his campaign in 2017 to take steps towards legalization immediately after assuming office. Michigan similarly stands ready to be the first state in the Midwest to legalize adult-use cannabis with a ballot initiative that, by some polls, is already supported by nearly 60% of registered voters. 

In Illinois and New York, non-medical possession and use has been decriminalized and both states are expected to take steps towards full legalization within the next two to three years. New York Governor Andrew Cuomo signed legislation in 2017 committing $10 million in state funds to ramp up the cannabis industry and has indicated political support for regulated hemp production and adult-use cannabis as a means to mitigate the state deficit. For Illinois, cannabis legalization will appear as a non-binding ballot initiative in November 2018 and has become a popular campaign platform in the democratic race for Governor. 

Other states with ballot initiatives and legislation to watch in 2018 include Connecticut, Delaware, Kentucky, Missouri, Ohio, Oklahoma, Rhode Island, South Dakota, Utah, Vermont, and Virginia. Vermont and Ohio, for example, reportedly intend to upgrade their existing cannabis laws with tougher regulations similar to those on the west coast. Connecticut, Delaware, and Rhode Island are apparently racing towards recreational use in effort to keep up with their northeast neighbors. Virginia is considering bipartisan decriminalization options, and Kentucky, Missouri, Oklahoma, South Dakota, and Utah are all candidates for medical marijuana ballot initiatives and bills. 

While 2017 was a year of significant growth in the cannabis industry, 2018 is shaping up to be a year of clarification and fine tuning. There are still many imperfections to work out in existing state regulations, and new entrants have a lot to learn from their pioneering peers. 2018 is also likely to be a milestone in the rise of cannabis campaign platforms and canna-business politics.

What is a Canna-Business?

The categorization of cannabis business (or "canna-business") can be difficult to pin down. Its scope is already quite large and continuously expanding. Current estimates place the total number of cannabis businesses in the Unites States somewhere between 25,000 and 33,000. That estimate, however, is not limited to farms and dispensaries. The criteria for cannabis business is reimagined regularly as entrepreneurs enter the industry and invent new ways to produce, package, market, and--of course--sell cannabis products and services.

As of January 2018, there are nearly 10,000 licensed cannabis cultivators and retailers in the United States, and approximately 3,000 manufactures and testing facilities. Such companies are often referred to as "plant-touching" entities. However, the bulk of the cannabis industry, is made up of approximately 20,000 companies that provide support or ancillary services, not only to cannabis licensees, but also to state regulators and consumers. Such ancillary services provide much needed expertise in both traditional and cannabis-specific areas, including compliance, consulting, education, equipment, legal, quality control, public relations, security, software and technology, and staffing. Because these businesses usually do not actually touch or process cannabis products, they are not subject to stringent licensing requirements and other state regulations. 

The increasing number of cannabis businesses is even more momentous when considering the number of people who work in the industry. Last summer, it was reported that the U.S. cannabis industry employed between 165,000 and 230,000 full- and part-time workers, surpassing dental hygienists, bakers, and massage therapists. Those figures, of course, have likely grown significantly with more recent legalization measures and industry entrants. California is the largest state in the country by population, and its recent roll out of adult use distribution and sales this past January has been predicted by some to eventually double the size of the current national market in terms of total businesses, employees, and sales by 2025.

Leaders in non-cannabis industries are taking notice as Cannabis sales are cutting deep into other traditionally profitable markets, including alcohol and pharmaceuticals. In areas where cannabis is legal, monthly liquor sales have been reported to drop by as much as fifteen percent, and many believe it is only a matter of time before cannabis sales meet and beat tobacco products. Alcohol titan Constellation Brands was one of the first and largest companies to publicly recognize cannabis as both a market threat and a potentially lucrative opportunity for expansion. In 2017, it purchased a ten percent stake in Canopy Growth, Canada's largest licensed cannabis producer. Analysts predict that there will be several similar big-name expansions into the cannabis industry, both in the U.S. and beyond, within the next five years. Further, the speculation of cannabis as a safer substitute for opioids and other painkillers has been widely studied and reported. Cannabis is expected to make a sizable dent in the prescription drug market by 2020.

In spite of the unprecedented growth and positive shifts in public perception, many cannabis businesses still have difficulty securing conventional business support from the financial sector due to stubborn stigmas, inaccurate assumptions, and unnecessary risk aversion. As with most industries, education and accurate assessment by financial institutions and services is crucial.

Risk Assessment, Not Risk Aversion

Cannabis is certainly a risky business, but not overwhelmingly so, and certainly not to the point that it should be written off as uninsurable or forbidden. Like any other enterprise, cannabis companies are exposed to ordinary property losses and litigious consumers. The biggest exposure for canna-businesses is, not surprisingly, product liability. However, limiting the scope of product liability coverage and charging enough premium to absorb the risk is just another day at the office for most insurers. There are solutions to every risk posed by the cannabis industry, it is just a matter of accurate rates and implementation.

At its core, the insurance industry is driven by risk. The success of the industry and the companies that run it depends in large part on consistent and accurate accounting of present and future loss exposures. It is paramount not only to be aware of changes in risk factors, but also to acknowledge and attend to new markets and influences as they emerge. The failure or refusal to accept new risks can be just as detrimental to insurer growth and success as imprecise form language, inaccurate rates, and careless claim or underwriting practices. 

The cannabis industry is quickly growing into a risk that cannot be ignored. Its roots are spreading far and wide in unpredictable patterns. In states where cannabis has been legalized, cannabis risks are finding their way into just about every line of personal and commercial insurance coverage, whether the insured is directly involved in the industry or not. It is no longer acceptable or responsible for insurers to subscribe to the wait-and-see approach and assume that cannabis coverage is not yet their company's concern. It is or soon will be unavoidable, and the perceived risks to insurers are largely built on misinformation and miscalculation. Despite federal and judicial uncertainty, there are at least three reasons to jump into the market now rather than later. 

First, the cannabis industry is already subject to more rigid regulations and surveillance than other "risky" industries. State licensing, zoning, and product requirements are extensive with few, if any, permitted exceptions. Most states require licensees to implement sweeping security measures and demonstrate their commitment to a laundry list of safety and health protocols. Thorough "seed-to-sale" product tracking is often a strict requirement, and the adoption of secure blockchain technology is strongly encouraged in states like Colorado and California, with others quickly following suit. All of the current regulations, requirements, and oversight arguably leads to reduced risks, fewer claims, more reliable data, and faster loss resolution. If an employee steals from the till or an altercation occurs on premises, there are dozens of cameras, security guards, and systems in place to verify the event. Similarly, if a canna-business exposes itself to product liability by failing to adhere to state regulations, the failure is generally well-documented, and the increased risk can be addressed via simple policy exclusions. 

Second, the threat of an imminent federal crackdown on the cannabis industry is just that: a threat, and one that is becoming more and more unlikely to be carried out. As cannabis legalization continues to gain favor in the non-partisan public eye and spread from state to state, the task of closing the floodgates or even turning back the tide of cannabis legalization becomes ill-advised at best, perhaps even insurmountable. The money being planted into and harvested from the industry speaks volumes with both state leaders and federal representatives. For many states, the cannabis industry is shaping up to be a solution to multiple catastrophic state-centric problems and it is building a following of loyal lawyers and policymakers.Earlier this year U.S. Attorney General Jeff Sessions revoked several Obama-era memos that promoted a "hands-off" approach for state legalization programs. In doing so, he provoked an avalanche of pro-cannabis responses from governors, legislators, and state attorneys general, and not just from states with legalization measures already on the books. Some political experts predict that Attorney General Session's intractable stance on cannabis may have the unintended consequence of motivating more states and members of Congress to take definitive pro-cannabis legislative action. In any event, it is unlikely that Congress and the Americans already invested in the cannabis industry would stand idly by if the executive branch elected to prosecute state-legal canna-business and consumption.

At the moment, state medical cannabis programs are protected from federal prosecution by the Rohrabacher-Blumenauer Amendment -- formerly known as Rohrabacher-Farr -- which prohibits the Department of Justice from spending federal funds to "interfere" with state medical cannabis laws and companies. However, the amendment is tied to the federal budget and has been subject to reconsideration several times with every temporary budget extension. The amendment also notably does not protect recreational cannabis laws and businesses. Although it is far from certain, there appears to be plenty of support in Congress for the amendment's continued existence, as well as its eventual expansion or introduction of an equivalent for the adult-use market.

Finally, beyond the threat of federal interference and prosecution, insurers may also be concerned over the apparent lack of court precedent for interpreting cannabis insurance provisions. While it is true that the market is new and that cannabis-specific policies have not yet been refined by decades of judicial scrutiny, the larger questions of contract enforceability have already been asked and answered, providing sturdy guidelines for future coverage litigation.  

In 2012, the federal district court of Hawaii determined in Tracy v. USAA Casualty Insurance Company that a homeowner does possess an insurable interest in her legally home-grown marijuana plants. Four years later, in Green Earth Wellness Center, LLC v. Atain Specialty Insurance Company, the Federal District Court of Colorado decided that the interpretation of cannabis insurance policies is a state issue to be determined according to state, not federal, contract laws. Like Colorado, California and the U.S. Court of Appeals for the 9th Circuit have acknowledged the dichotomy of state versus federal cannabis law but have concluded that the focus of enforceability rests primarily on illegal conduct, not illegal objects. Even where a contract concerns illegal subjects such as cannabis, the court will generally enforce it if it is possible to do so without requiring the parties to engage in illegal conduct. In other words, courts are very likely to continue to adhere to their time-honored tradition of enforcing the insurance contract, especially where doing so adheres to the public policy of protecting the reasonable expectations of the insurance consumer.

Cannabis Coverage

Canna-businesses and regulators have been calling for quality cannabis insurance options for years. Surplus lines carriers have been answering with specialized products. However, these products are mostly built upon existing standardized coverage forms. The tools for cannabis coverage are already out there, and more are on the way. 

The California Department of Insurance, led by Commissioner Dave jones, is the most recent state regulator to put out the call for more cannabis insurance options. In early 2017, Commissioner Jones introduced a cannabis initiative geared towards helping educate insurance carriers about the burgeoning multibillion-dollar cannabis industry and encouraging those carriers to enter the market. In October 2017, ahead of the January rollout of California's legalized adult-use regulations, Commissioner Jones hosted a public hearing aimed at identifying insurance gaps currently plaguing cannabis businesses. The Commissioner solicited feedback from insurance industry representatives and was assured that both surplus lines and admitted carriers are eager to serve at the intersection of the largest insurance market in the U.S. and the largest cannabis market in the world. 

The California initiative follows similar calls for increased insurer participation made by other adult-use states. The Oregon Division of Financial Regulation, for example, has publicly criticized the lack of clarification in existing policies issued to Oregon businesses and consumers with respect to the availability and scope of coverage for cannabis items and activities. Oregon issued a bulletin requiring property and casualty insurers to specifically state in all future policies whether cannabis coverage is provided. 

While some canna-business exposures may be somewhat nuanced and require special attention, responsive standardized coverage forms are becoming more and more available. In addition to the growing field of surplus lines cannabis carriers, the California Department of Insurance has approved a suite of commercial liability forms submitted by Golden Bear Insurance Co., as well as a surety bond program offered by Continental Heritage Insurance Company. Other providers and insurance organizations are joining the cannabis caravan, including national advisory organizations like the American Association of Insurance Services (AAIS). 

During the October 2017 California panel hosted by Commissioner Jones, AAIS reported that it was developing a Cannabis Businessowners Program (nicknamed "CannaBOP"). The AAIS' CannaBOP line is a stand-alone. 

The Demotech Difference Summer 2018 property and liability package program supported by comprehensive rules and loss costs. The new product was filed with the California Department of Insurance on April 20, 2018. It is approved for use as of June 1, 2018. AAIS plans to expand CannaBOP into other adult-use jurisdictions, including Colorado, Oregon, and Washington, and is currently developing additional cannabis-specific programing for agriculture and personal lines.

Cannabis cultivation insurance is a particularly hot issue for participating insurers. Surplus lines are serving the market, but with major reservations. Of the insurance that is available, most is egregiously overpriced and overly restrictive, often pushing the threshold of illusory coverage. As a result, California growing operations are notoriously underinsured as they still struggle to recover from some of the most devastating wildfires in 2017. Dozens of cannabis cultivators, large and small, suffered millions in uninsured damages. Those whose crops survived the fires still face significant product liability exposures for their place in the chain of production. AAIS is aware of these issues and is working to introduce standardized agriculture insurance solutions by 2019.

For those companies still not convinced to enter the cannabis coverage arena, or who are just interested in clarifying coverage under their existing lines of business, cannabis specific exclusion endorsements are becoming widely popular. AAIS has developed a broad cannabis "items and activities" exclusion for use in Oregon and California. The exclusion endorsement is applicable to all programs except CannaBOP and other future cannabis-specific coverages. The endorsement will soon be filed and made available for use on a nationwide basis. 

The cannabis industry has expanded to the point that further growth and market influence is inevitable. However, the industry is still largely underinsured, posing significant risks to companies and consumers alike. Even cannabis critics will agree that there is an urgent need for more cannabis-specific insurance options to help mitigate some of the uncertainty surrounding the scope of coverage available under more traditional insurance products. The market is calling, the risks are manageable, and reliable tools are available. There has never been a better moment to turn over a new leaf with cannabis insurance.


Phillip Skaggs is Assistant Counsel at the American Association of Insurance Services (AAIS), where he aids in the research and development of standardized property and casualty insurance products and advises the company on various legal and compliance matters. Phil also helps manage AAIS cannabis insurance initiative, which is tasked with evaluating how insurance producers can best respond to the complex risks of the legalized cannabis industry and regulatory climate.

Established in 1936, AAIS continues to serve the Property & Casualty insurance industry as the only national nonprofit advisory organization governed by its member insurance carriers. AAIS delivers tailored advisory solutions including best-in-class policy forms, rating information and data management capabilities for commercial lines, inland marine, farm & agriculture and personal lines insurers. Its consultative approach, unrivaled customer service and modern technical capabilities underscore a focused commitment to the success of its members. For more information about AAIS, please visit www.aaisonline.com.

Source: Demotech