PLUS Webinar: Takeaways From a Cannabis Underwriter

This post was first featured in The Roundup — the place where insurance specialists from the Founder Shield family share their insights and takeaways from the panels, summits, conferences, etc., in which they participate side-by-side with other valued professionals.

In this piece, VP of Scale Underwriting Matt McKenna joins the PLUS four-person panel to discuss challenges facing the cannabis industry and how underwriters navigate these hurdles. Many thanks to the following folks for sharing their thoughts and opinions on this subject:

• Mike Rowley from Aon Affinity
• Ian Stewart from Wilson Elser
• Walt Baker from Golden Bear Insurance Co. 

What are the challenges for underwriters who are creating new cannabis products?

Only a nuanced approach to this question is appropriate — and it comes in three parts:

1. Lack of federal legalization

The lack of backing from the federal government limits the number of capacity providers (i.e., carriers, fronts, and reinsurers) willing to back a product. For example, Lloyds of London is the original backer of Scale’s Management Liability Program but hasn’t joined our program yet. 

Naturally, the uncertainty adds challenging variables and unknowns to loss projections. Instead of a data-centric approach, capacity providers must rely on favorable legislative trends and the wits of their underwriters to ensure their product is viable. 

2. Youth of market 

In the same vein, the limited amount of actuarial data around management liability for private cannabis companies adds an element of the hypothetical to conversations. But reinsurers don’t like hypotheticals and “gut takes” — they like data.

3. Rapid evolution of market

The cannabis industry is evolving at lightning speed, with new capacity providers and competitors appearing nearly every month. But that’s just for starters. Other rapid developments also muddy the waters and make for challenging conversations with current and prospective capacity providers, such as: 

• Changing risk exposures (i.e., regulatory treatment of Delta-9)
• Rapid influxes of insureds after state legislation changes
• Macro pressures on the cannabis industry

What is it about cannabis companies that makes coverage more limited than the standard commercial executive risk marketplace?

As underwriters, we’re required to consider how the cannabis industry’s unique exposures increase the likelihood of a claim. The following are some of our main concerns (and most common exclusions). 

Financials

Complex organizational structures (with intercompany transactions), volatile cannabis market dynamics, and governmental burdens, such as IRC Section 280E, make the cannabis market challenging for participants. Subsequently, these companies appear less attractive to a directors and officers (D&O) underwriter conducting a financial analysis for many reasons, such as:

Insolvency 

There is a smaller universe of investors and financing options available to cannabis companies than others. The SAFE Banking Act is in headlines nowadays, with the potential to change the landscape — but it stalled…again. 

ABC restructuring

Bankruptcy courts aren’t open to companies selling illegal substances. As a result, the Assignment for the Benefit of Creditors (ABC) changes the risk profile for cannabis companies, especially relative to others in the commercial space.

Creditors

Cannabis startups are sometimes asked to take on riskier debt than their non-cannabis counterparts, who can rely on more standard commercial loans or convertible debt instruments like SAFE notes.

Regulatory exposure

A SaaS company doesn’t have to worry about the Drug Enforcement Administration (DEA), nor do its underwriters. Unfortunately, many regulatory conflicts occur at the local, state, and federal levels, adding exposure to cannabis companies.  

As imagined, D&O underwriters address these concerns through premiums, retentions, and exclusions. However, licensing requirements change dramatically depending on the cannabis business. For example, consider the difference between a vertically integrated multi-state operator (MSO) and a small glassware manufacturer. These dynamics change operational costs and legal exposures. 

The takeaway is that a one-size-fits-all approach doesn’t work in the cannabis insurance marketplace. Strangely enough, even ancillary cannabis companies also have trouble getting coverage. 

Product liability

Cannabis companies must often be hyperaware of unsafe labeling, product defects, and false advertising exposures. 

Competition

The “growing pains” of a rapidly evolving marketplace and an active Department of Justice create complexities in underwriting cannabis companies. 

Employment-related liability

Let’s get straight to the point; a higher existential risk means greater employment practices liability (EPL) risk. Take the following two states as examples:

• California is a very problematic state from an EPL standpoint, yet, it also happens to be the largest cannabis market in the country!
• Illinois presents challenges with its Biometric Information Privacy Act (BIPA). Although biometric data collection is standard in cannabis — a factor we undoubtedly consider in underwriting — large companies and all companies in Illinois face more risk. 

What are some of the regulatory and legal challenges facing cannabis operators?

As mentioned above, the IRC Section 280E is an undue burden, creating fewer financing and banking options for cannabis companies. The MORE Act will also catapult changes to the cannabis market, not to mention the revival of parts of the defeated SAFE Banking Act as it unfolds in the form of the America COMPETES Act of 2022. 

Every market player — insured and insurer markets — will feel an immediate crowding that wasn’t there the year before. Established cannabis companies will have more access to capital than they did prior. Still, massive players waiting on the sidelines will also make their presence known (Monsanto, perhaps?). 

Furthermore, insurers who have had a run of the marketplace for the last several years will now find themselves in the company of household names like Chubb and AIG.

Lastly, Labor Peace Agreements add more complexities; however, we view them as a more user-friendly version of NLRA/NLRB rules and not necessarily bad. But they are an additional requirement that many other companies do not face.

What is a “good” cannabis submission?

We want to quote — but the quality of the submissions in the cannabis executive risk space makes it challenging for us to do our jobs. Let’s cut to the chase; here’s what we need:

• A completed application, capitalization table, and detailed financial for the current and prior year 
• A corporate organizational chart and consolidated financials if it’s a complex corporate structure
• All supplemental applications
• Bios (i.e., founders, management team, etc.); Get us comfortable with them, and show us that the leading players aren’t entirely new to the industry and its various pitfalls. 

Insured must understand a D&O underwriter’s natural skepticism, not to mention that they’re under high scrutiny when quoting cannabis submissions. We need to build substantial underwriting files to ensure our capacity providers remain comfortable with insuring emergent risks. 

At the end of the day, these companies need to be financially strong before they can expect to receive competitive management liability terms in this insurance market.

Protecting your cannabis company can seem confusing; however, we’re a full-service insurance brokerage working with carriers worldwide to offer you the best coverage possible. We’re here to help! Please reach out to us today by emailing [email protected] or calling 646-854-1093 for a customized letter of commitment or learning more about your cannabis insurance options.