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Cannabis and Captive Insurance

Marijuana Wallpaper 600x300
June 11, 2018

Last month, the MJBizConNEXT conference convened in New Orleans. According to its website, the conference seeks to attract "decision-makers who are disrupting the cannabis space from all across the US [and elsewhere] and across all segments of the [cannabis] industry." Conference organizers said that the convention drew 3,100 attendees and 278 exhibitors from across the cannabis business spectrum, including growers, lawyers, accountants, venture capitalists, cultivation operations directors, and dispensary human resource consultants, to name a few. This year, the event also attracted at least one captive insurance manager, Emerald Risk Solutions.

Emerald Risk Solutions specializes in tailored captive insurance solutions for legal cannabis affiliated businesses. Amye King, Emerald Risk Solutions' national sales director, said the firm's tagline, "Protecting Green from Seed to Sale," is in reference to the captive insurance solutions it provides for growers, dispensaries, cultivation facilities, distributors, processors, and manufacturers at any stage of the cannabis production cycle. The cannabis industry (the cannabis industry encompasses medical marijuana, recreational marijuana, and hemp production) is subject to extensive seed-to-sale rules and regulations surrounding growing and distributing cannabis from the time a seed is planted to the point of sale. Cannabis businesses are required to keep meticulous records tracking every move the inventory makes.


In 2016, the US legal marijuana market was $6.7 billion; it is projected to be over $22 billion by 2021. It is legal for medical use in over half of the 50 states. Several states have legalized it for personal adult use ("recreational" use), yet it remains a Schedule I substance under the Controlled Substances Act (CSA). The CSA prohibits any use or possession of Schedule I substances. This conflict of law is resulting in more questions than answers for insurers and risk managers.

Marijuana Shopping Cart

Marijuana/Cannabis/Hemp. Marijuana consists of the dried flowers and leaves from the Cannabis sativa plant. The cannabis plant contains over 500 chemicals, including over 100 different cannabinoids, one of which is a psychoactive substance known as delta-9-tetrahydro-cannabinol (THC). THC is the primary cause of the "high" that results from ingesting marijuana. Marijuana is most commonly ingested via smoking, but it can also be consumed via food items (e.g., candy, brownies, cookies, etc.) as well as by vaporization and tinctures.

The cannabis plant is also sometimes referred to as hemp; however, they are not the same. Cannabis and hemp have certain genetic differences, and the two are different primarily in terms of their THC content. Marijuana is used for medicinal and recreational purposes, whereas hemp is largely used for industrial products, such as housing construction materials, clothing, and paper.

Today's Legality and Illegality of Cannabis. Today, cannabis is classified as a Schedule I substance under the CSA of 1970 (see Title 21-Food and Drugs, Chapter II-Drug Enforcement Administration, Part 1308). Schedule I drugs are defined as "substances that have a high potential for abuse, have no currently accepted medical use in treatment in the United States, and there is a lack of accepted safety for use of the drug or other substance under medical supervision." Other Schedule I substances include heroin, peyote, and lysergic acid diethylamide (LSD). According to the CSA, a federal law, it is illegal to possess or use a Schedule I substance in the United States.

Marijuana Justice Scales

Despite marijuana's illegality at the federal level, 29 states plus the District of Columbia have legalized the use of marijuana for medical purposes ("medical marijuana").1 Nine states plus the District of Columbia have legalized the recreational use of marijuana by adults (Alaska (2015), California (2016), Colorado (2012), District of Columbia (2014), Maine (2016), Massachusetts (2016), Nevada (2016), Oregon (2014), Vermont (2018), and Washington (2012)). Other states have decriminalized possession of marijuana to the point that punishment for it is virtually nonexistent.

Additionally, 18 states have what are known as "CBD-only laws." CBD stands for cannabidiol, which is a derivative of the marijuana plant. CBD does not contain THC and thus does not have a psychoactive response. It is used in the treatment of various medical conditions, especially seizures in children. CBD is also sometimes used as a nutritional supplement and is considered by many to be a very valuable extract from the marijuana plant.

Enforcement of the CSA. The federal government has largely taken a "hands-off" approach to enforcing the CSA with respect to marijuana in states that have deemed it legal.

Through what came to be known as the Ogden memo2 (2009) and the Cole memo3 (2011), the Obama administration set forth guidelines for states to follow regarding the regulation of marijuana. These memos outlined the conditions under which the federal government would take a hands-off approach to enforcing the CSA. For instance, one such condition was that access to marijuana by minors be restricted.

In 2014, two laws took effect that favored legalization. One was the Federal Farm Bill of 2014 (specifically Section 7606), which opened the door for states to authorize industrial hemp farming. Until that point in time, hemp was a Schedule I substance along with cannabis. Additionally, in December 2014, the Rohrabacher-Farr amendment was passed as part of the omnibus spending bill. This prohibited the US Justice Department from spending funds on enforcing the CSA in states that have legalized marijuana. This amendment does not change the legal status of marijuana, and it must be renewed each year to remain in effect.

Attorney General Jeff Sessions has publicly stated on numerous occasions that he opposes marijuana, and in the Sessions Memo4 (2018), the Trump Administration directed all US attorneys to use all of the tools at their disposal surrounding federal marijuana enforcement.

Currently, Rohrabacher-Farr prevents the attorney general from doing much about the situation. Most recently the amendment was renewed on March 23, 2018, as part of an omnibus spending bill (in effect until September 30, 2018). In the event the amendment is not renewed in the future, the US Department of Justice can start enforcing the CSA in states that have legalized medical marijuana.

Insurance for the Marijuana Industry

Laws and Regulations. The uncertain legal standing of businesses in the marijuana industry has made it challenging to insure these types of businesses. Admitted insurers have, so far, been hesitant to enter the business, and the standard policy forms are often not clear as to the extent that they will cover claims related to recommending, growing, and selling cannabis products.
Marijuana Road
The McCarran Ferguson Act of 1945 leaves the regulation of insurance up to the individual states and generally guarantees freedom from federal interference as long as the states do something to regulate the insurance transaction. Until 2016, the courts supported an insurer's right to deny property insurance coverage for marijuana, and to date, there have been very few court decisions regarding liability insurance coverage associated with marijuana.

In 2016, the US District Court for the District of Colorado ruled differently on the matter in Green Earth Wellness Center LLC v. Atain Specialty Ins. Co., Civil Action No. 13-cv-03452-MSK-NYW, 2016 U.S. Dist. LEXIS 18999 (D. Colo. Feb. 17, 2016). Green Earth filed two claims for damage with Atain, and Atain denied both. Green Earth then sued for failure to pay, unreasonable delay, and bad faith. Atain argued that the federal illegality of marijuana should preclude payment of the claim. The court ruled that Colorado law—not federal law—governed the contract, and Green Earth was in compliance with Colorado law.

Atain also argued that marijuana was precluded from coverage by the contraband exclusion in the policy. The judge ruled that the exclusion was ambiguous. Finally, Atain sought to invoke the CSA to have the contract declared illegal. The court responded, "Atain, having entered into the Policy of its own will, knowingly and intelligently, is obligated to comply with its terms or pay damages for having breached it."

While the scope of this article does not extend to a comprehensive discussion of all cannabis-specific case law, the court system will most certainly be testing legal conflicts for years to come.

There are also several laws and agencies that have some impact on marijuana use in the workplace. The legal climate for employers is changing rapidly. In some states, it is perfectly legal to deny accommodation for medical marijuana in the workplace, and in other states, it is not. In the vast majority of states, it is also permissible to deny the provision of marijuana as a workers compensation benefit. However, the main basis for this legal climate is marijuana's Schedule I status under the CSA, and that could change in the future.

Jason Horst, coverage attorney with Horst Legal Counsel in Northern California, said that from a risk management perspective, the most difficult questions and problems are those concerned with the workplace. Employers have legitimate concerns about how marijuana use affects the safety and productivity of their employees. On top of that, conflicts among current laws governing the workplace can make it difficult for employers to know for certain whether they are on firm legal ground in enforcing antidrug policies with respect to marijuana. In short, legalization of marijuana is a challenging and important issue for the risk management and insurance community.

Coverage from the Marketplace. Due to the historical reluctance of most admitted insurers to write coverage for cannabis businesses, most of the solutions to date have come from the excess and surplus (E&S) lines marketplace. Insurance coverages available in the E&S marketplace today for cannabis businesses include the basic coverages: general liability, property, and auto liability coverages. Products liability and excess liability coverage are also available. Crop coverage for indoor crops at any stage of the growth cycle ("from seed to sale") can be purchased. Outdoor crop coverage is extremely difficult to obtain.

Marijuana Seedling

There are professional liability policies for doctors and other practitioners who recommend medical marijuana to patients.5 Because marijuana is a "data-driven" industry, there are cyber-liability policies for dispensaries to cover losses resulting from a data breach. And, because marijuana is both a very valuable substance as well as a cash-based business, cannabis entrepreneurs can even purchase kidnap and ransom coverage.

Those who purchase these insurance products should be leery of exclusions and limitations for "contraband," "illegal substance," "Schedule One," and/or "banned substances." When possible, coverage limitations associated with such terminology should be negotiated out of the policy, as they may ultimately be used to try and deny coverage for otherwise legitimate claims.

Mr. Horst said an insurer needs to take on cannabis distribution risk knowingly and the policy should either clearly provide coverage or clearly exclude coverage. Otherwise, the loss or coverage will be denied.

The market for cannabis business coverages is still quite fluid, with changes happening every day. Admitted insurers have been quite reluctant to write cannabis business until recently. However, this appears to be changing.

While speaking on the Alternative Risk Transfer for the Cannabis Industry—Opportunities and Risks panel at the 2018 Captive Insurance Companies Association (CICA) conference (2018 CICA cannabis panel), Joe Holahan, attorney at Morris, Manning & Martin, LLP, said that outside of California, Colorado, and Washington, the insurance landscape is more difficult and that California, being the largest market for the cannabis industry, will entice commercial insurers.

  • According to a May 2017 press release6 by Continental Heritage Insurance Company (Continental Heritage), the Ohio-based insurer began a surety bond program for applicants to Ohio's Medical Marijuana Control Program. The Ohio Medical Marijuana Control Program application rules for marijuana cultivation licenses require applicants to either post cash collateral or a surety bond ($750,000 and $75,000 depending on the cultivation category) issued by an authorized insurance company to demonstrate financial reliability.

  • The California Department of Insurance (CA DOI) indicated in a February 2018 press release7 its approval of Continental Heritage to offer surety bonds to California cannabis license seekers. Most of the state's licensed cannabis businesses are required to have a $5,000 surety bond. According to the same press release, "Surety bonds are required by licensing agencies to guarantee the behavior of licensees. A license bond guarantees that the entity will comply with the laws and regulations for that entity. These bonds ensure compliance with licensure and permit requirements, and guarantee payments related to the cost incurred for the destruction of cannabis goods and materials in the event of a violation of the applicable regulations."

  • In November 2017, Golden Bear Insurance Company (Golden Bear) became the first admitted insurer to provide commercial insurance coverage to cannabis businesses licensed by California according to a CA DOI press release.8 Speaking on the 2018 CICA cannabis panel, Camille Dixon, director of cannabis insurance policy with the CA DOI, said that Golden Bear will write commercial general liability, premises liability, and crime and theft coverage.

  • California Mutual Insurance Company became the first insurer approved to add lessor's risk coverage for landlords renting to the cannabis business according to a May 2018 CA DOI announcement,9 which said, "Lessor's Risk coverage provides liability and property insurance for commercial property owners who lease building space to commercial tenants. Specific commercial activities and businesses addressed by this coverage include cannabis labs, product manufacturing, cultivation, and dispensary operations."

  • Also in May 2018, the CA DOI approved10 Continental Heritage Insurance Company to provide product liability and product recall coverage for commercial cannabis activity in the state. The program offers coverage to licensed cultivators, manufacturers, distributors, retailers, and medical but excludes laboratory testing.

  • On June 4, 2018, the CA DOI announced that it had approved11 California's first Cannabis Business Owners Policy (CannaBOP). The program was devised by the American Association of Insurance Services for cannabis dispensaries, storage facilities, processors, manufacturers, distributors, and other cannabis-related businesses operating in California.

Mr. Horst said, "At present, this is an industry with entrepreneurs that are inherently not risk averse and that are generally underinformed about insurance. Business risk is muted when you are living with a 20-year jail sentence hanging over your head." However, he explained that for legal cannabis affiliated businesses, insurance is now a prerequisite for compliance purposes. He continued, "Distributors will be seeking GL coverage—not because they necessarily worry about risk, but because state regulations and local jurisdictions are requiring companies to 'cover up' in various ways."

Mr. Horst said that the key will be to teach risk management to the cannabis industry and why it is valuable to manage risk to protect lives and livelihoods. His hope (and mission) is that the cannabis industry will eventually become increasingly cognizant of risk management and insurance coverage, similar to the construction industry where every subcontractor in the United States is conversant with coverages and where there are industry-wide best practices based on what insurance is required and state-of-the-art best practices.
Marijuana Rider

In view of this, California Insurance Commissioner Dave Jones announced12 that he "convened meetings between commercial insurance company executives and cannabis business owners to educate the insurance industry about the sophistication, professionalism, and risk management of the cannabis industry and has also organized tours for insurance executives at cannabis businesses."

With risk management practices taking root and gaining credence and with available admitted commercial insurance options gaining traction, according to Mr. Horst, the cannabis industry still remains under covered or without coverage.

On the 2018 CICA cannabis panel, Camile Dixon said that the greatest need is for outdoor crop insurance, as there is currently no appetite for this in the commercial market. In addition, she said other hard-to-get insurance includes key man, excess product liability (policies are generally available in the $1 million–$5 million limit range), and stock throughput for distributors with outdoor transit. Mr. Horst said that while indoor crop insurance is available in the commercial market, it is very expensive.

Not surprisingly, federal crop insurance is not available for marijuana growers and the Federal Crop Authority has no plans to develop a program. Surplus lines policies are currently based on traditional general liability and farm property bureau forms that are designed for static risk. The dynamic risk of crop failure and market value that crop insurance addresses are not available to cannabis.

Cannabis and Captive Insurance

On the 2018 CICA cannabis panel, Greg Fanoe, consulting actuary at Merlinos & Associates, Inc., said, "Cannabis needs insurance and is an industry that can benefit from the use of captive insurance." Mr. Fanoe advised that he knows of three captives that are already writing or applying to write coverage for the unique product and crop risks presented by cannabis.

The captive management firm Emerald Risk Solutions formed in response to the devastation it saw come out of the 2017 CA wildfires. Specifically Humboldt, Mendocino, and Trinity Counties in Northern California, known as the Emerald Triangle (the firm's namesake), are home to family-owned and -operated cannabis businesses. Amye King said, "Instead of grapes, these families have decided to grow cannabis from northern CA to southern OR, where ideal growing conditions exist. The products that come out of the emerald triangle are like no other—like Napa Valley is for grapes."
Marijuana Outdoors
Emerald Risk Solutions seeks to assist legal cannabis business owners (those operating in any state and with a permit or a license) in unraveling their cannabis risks and exposures to see if a captive solution is right for them. Where these businesses cannot get coverage in the traditional commercial market, Emerald Risk Solutions provides a captive solution for supplemental coverage to fill in gaps or exclusions. Potential risks for captive consideration include loss or damage to outdoor crops, cyber attacks on retail operations, a business interruption caused from a product recall, or the ongoing possibility of a regulatory audit/investigation. According to Ms. King, "This industry requires a great deal of investment prior to any profits being made, and the risk for a loss is significant."

While Emerald Risk Solutions performs a risk assessment, an outside actuary formulates the premium amount based on the insured's unique risks and exposures, market data (there isn't much yet), market conditions, and overall risk tolerance. When working with an emerging coverage or product, Ms. King shared, "Our actuary tends to rely on available industry data with standard inputs until there is enough information to justify doing something different. The distinction is when the industry tends to make a rate adjustment for the class of business (or crop in this case), there may be a strong argument that cannabis would be in a higher-risk class."

The Emerald Risk Solutions captive insurance model involves a cell structure with a risk pool in the core, according to Ms. King. The key, she said, is to work with the department of insurance in the captive domicile to gain approval to issue insurance policies to a legal cannabis business owner while following all of the captive domicile's regulations, compliance requirements, and laws.

In the end, said Ms. King, "These are business operations, and smart business owners want insurance protection." A grower with 1 acre of outdoor cannabis crop might produce $150,000–$200,000 in revenue in some states. Most large growers in California produce upwards of 300 acres and may likely have a vertical business, meaning they have been granted local permits and state licenses to legally cultivate, extract, and distribute cannabis and cannabis-related products. "Such businesses are currently unable to obtain adequate and affordable insurance protection in the market," said Ms. King, "and captive insurance may be able to provide the solution."

Footnotes are available here.

This article is based on "Legalizing Marijuana: Risk Management and Insurance Implications," by Brenda Wells, director at East Carolina University in the College of Business Risk Management and Insurance Program in Greenville, North Carolina, The Risk Report,Volume XXXX, No. 5, January 2018, and information presented at the IRMI Agribusiness Conference (AgriCon) from the "Got Weed? Emerging Risks From Marijuana Legalization" presentation, May 2018, both published by © 2018 International Risk Management Institute, Inc.
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