Cannabis and Captive Insurance

Legal annual cannabis sales in the United States surpassed $31.8 billion in 2023 and are projected to reach $507 billion by 2028, according to research firm Brightfield Group, as demand continues to increase dramatically.

A total of 38 states and the District of Columbia have legalized some form of medical marijuana, while recreational marijuana is legal in 19 states and the District of Columbia.

Yet, under the Controlled Substances Act (CSA), cannabis is classified as a Schedule I drug, making it illegal at the federal level.

These conflicting federal and state laws, the merging standardization of business practices, and rapidly evolving regulations have discouraged insurers from entering the market.

As a result, cannabis-related businesses (CRBs) have often found it extremely challenging to secure affordable and comprehensive coverage.

Cannabis, Marijuana, and Hemp

The Cannabis sativa plant contains more than 500 chemicals, including in excess of 100 different cannabinoids (CBDs). One such cannabinoid is a psychoactive substance called delat-9-tetrahydro-cannabinol (THC), which is the primary cause of the "high" resulting from ingesting marijuana.

Marijuana consists of the dried flowers and leaves from the cannabis plant. It is most commonly ingested through smoking, but it can also be consumed in food items, by vaporization, and with tinctures.

Hemp is similar to but genetically different from marijuana. Hemp is defined as a cannabis plant that contains 0.3 percent or less THC, while marijuana has more than 0.3 percent. Marijuana is used for medicinal and recreational purposes, whereas hemp is largely used for industrial products such as construction materials, clothing, and paper.

Legal Status of Cannabis

As a Schedule I drug, cannabis is stated to have "no currently accepted medical use in treatment in the United States," according to the CSA. Under this federal law, it's illegal to possess or use a Schedule I substance in the United States.

In May 2024, President Joe Biden announced that marijuana had been reclassified from a Schedule I drug to a Schedule III drug under the federal CSA. The proposal still needs final approval by the US Drug Enforcement Agency (DEA).

A provision in the 2018 Farm Bill also removed hemp from the list of Schedule I controlled substances. As such, the DEA will not consider hemp-derived CBD as a controlled substance subject to the CSA.

However, cannabis and CBD are subject to Federal Drug Administration (FDA) approval under the Federal Food, Drug, and Cosmetic Act (FD&C Act). The FDA has not approved a cannabis drug. However, it has approved CBD medicines for epilepsy treatment.

Federal law currently prohibits CBD from being added to any food or drink product. On July 22, 2019, the FDA issued formal letters determining that certain CBD products were sold in violation of the FD&C Act.

Insurance Risks

CRBs face many risks and obstacles in finding insurance coverage. They have the same general liability and other risks that agricultural and manufacturing businesses face, including workplace accidents, damage to property, and crop failure.

CRBs are especially prone to fires from both wild and internal sources. Some of the biggest risks involve theft, general liability, and product liability.

Companies operating within a state's legality also face severe banking restrictions due to federal regulations. It's estimated that approximately 70 percent of CRBs operate solely as cash-only businesses and have no formal relationship with a bank. As a result, they may be forced to handle large sums of cash, subjecting them to a higher risk of theft and increased liability.

However, the Secure and Fair Enforcement (SAFE) Banking Act, introduced and passed by the House of Representatives in April 2023, gives CRBs access to financial institutions' products and services. It is currently awaiting further action in the Senate.

Another piece of legislation, the Clarifying Law Around Insurance of Marijuana (CLAIM) Act, was introduced in the Senate in March 2021, where it currently awaits further action. The CLAIM Act would allow insurers to provide coverage to cannabis businesses without the threat of federal prosecution.

The popularity of cannabis-infused products, such as edibles, also increases the risk of product liability and safety recalls. The psychoactive effects of cannabis raise the risk that products may be deemed mislabelled, misrepresented, or harmful.

Standard general liability plans account for these claims in non-CRB businesses, but most insurers are reluctant to provide such coverage for CRBs due to legal uncertainties. Therefore, policy language specifically tailored to the cannabis industry is critical in providing adequate coverage.

Individuals using cannabis also face insurance challenges, ranging from legality issues to coverage deficiencies. Users may be faulted in workers compensation claims or subject to employment-disqualifying drug screening. In addition, insurers offering medical treatment options may have policies preventing the use of cannabis in treating a patient's condition.

Auto insurance rates may also be influenced by elevated risks associated with drivers under the influence. Complicating the situation is the lack of standardized methods for roadside detection of drug-impaired driving. Additionally, the variability of side effects and physiological reactions in each user increases the risk of misidentifying a driver's status at the time of the incident.

"Cannabis businesses need coverage for the same types of risks that comparable mainstream businesses require insurance for also," said Jason Horst, managing partner at Horst Legal Counsel. "Dispensaries generally have the same operational risks as the other retailers.

"Cannabis distributors share common risks with distributors of other types of goods. Cultivators face the same types of risks as growers of other agricultural goods.

"Underwriting those risks, however, is obviously different, due to the value of the products in question in the legal and illicit markets, their intoxicating nature, and their relative novelty. On the one hand, these factors increase the risk of theft and product liability across the supply chain. On the other hand, cannabis businesses typically operate under far more stringent regulatory regimes than those outside the industry, inherently mitigating some of their operational risks."

Mr. Horst added that the most common inquiry he receives is from companies looking to use section 831(b) of the Internal Revenue Code to get around federal tax laws related to trafficking a controlled substance. Currently, he said, IRS Code 280E precludes companies that do so from taking the deductions for ordinary business expenses that most rely on.

"The thought was channelling the funds through a captive could mitigate the impact of 280E," said Horst. "But when you start digging into the details there is no actual risk sharing or risk transferring happening. The coverage provided is largely illusory."

Securing Coverage

Finding and securing adequate insurance coverage for CRBs can be challenging, but the insurance market has grown and matured in recent years. According to a 2021 report by New Dawn Risk, there are currently about 30 US insurers offering cannabis coverage, up from only 6 in 2020.

Insurers and brokers do not formally advertise their services to CRBs because of federal laws around cannabis. Instead, most CRB owners hear about insurance options through word-of-mouth in the cannabis community.

When CRBs do find and obtain coverage, most need to pay their premiums in cash, which presents another obstacle most other businesses don't face.

In addition, most insurers offer $1 million per occurrence/$2 million aggregate policies in commercial and general liability, property damage, and product liability coverage, well under the required limits of up to $5 million and $10 million or more.

Some product liability policies also carry health hazard endorsements, which arguably render them useless. Moreover, most policies tend to contain highly specific protective safeguard warranties that are often overlooked until insurers raise them to deny claims.

However, a more fundamental challenge is the lack of understanding and prioritization of enterprise risk management and coverage within the cannabis industry. Even when it comes to insuring existential risks, the price often drives procurement decisions rather than terms, and this dynamic only further disincentivizes insurers to write more comprehensive policies.

"Cannabis insurance is far behind the times in regards to limits, coverage and accessibility," said TJ Frost, president of Symphony Grow, the specialty business of Risk Solutions. "Over the last 10 years we have seen great strides but we are still in the first inning of a pre-season baseball game.

"We are seeing a lot of claims with EPLI, D&O, crime (theft) and property. The largest risk that carriers were afraid of was product liability, but we haven't seen many of those claims."

However, as the market has evolved and data is more widely available, there are more viable and legitimate coverage options on offer, some quite sophisticated, namely captives. For example, captive risk retention groups that include multiple public cannabis companies.

"Properly employed, captives can offer cannabis companies the ability to proactively manage risks better than they can currently manage them through conventional insurance, as well as potentially seeing significant tax advantages," said Mr. Horst.

Mr. Frost said that prior to the launch of his company's captive solution, there were few options available outside of workers compensation insurance. Over the last couple of years, he said that it has found a trading partner to form it and built an expert captive team to run it.

"We have the ability to do a single parent captive, group captive and segregated cell captive," said Mr. Frost. "Each one is different and holds different appetite."

Future of Cannabis Insurance

There are many legal uncertainties, unique hazards, and emerging risks involved in legal cannabis-related activities.

The National Association of Insurance Commissioners formed a Cannabis Insurance Working Group in 2018 to better understand the cannabis industry's insurance coverage gaps and regulatory issues. As a result, members have been developing best practices for state insurance regulators to help them address these insurance needs. As part of this process, the Working Group adopted the Understanding the Market for Cannabis Insurance white paper in 2019.

On June 2, 2021, the Working Group chair presented a memorandum from the Working Group recommending that the Government Relations Leadership Council membership issue letters in support of and advocate for the passage of the SAFE and CLAIM Acts. The proposed bills would expand coverage options for businesses and remove federal barriers for insurers to carry out business with CRBs that are legal in their respective states.

The Working Group recently revised and edited a new draft of the 2019 white paper, Understanding the Market for Cannabis Insurance: 2023 Update. Topics for inclusion include recent federal legislative actions, current information on cannabis regulation and licensing, and updated cannabis insurance needs and policies currently available. Emerging issues in the cannabis space, such as minor CBDs and on-site consumption lounges, are also addressed in the paper. The group earned the final adoption of the paper during the 2023 Summer National Meeting.