The market progresses despite a
lack of complete legal clarity
By Joseph S. Harrington, CPCU
You can’t regulate what you don’t allow. That was the lesson of alcohol Prohibition 100 years ago. But apparently someone forgot, because today’s federal ban on the manufacture, sale, or distribution of cannabis—a ban on paper that is rarely enforced in practice—effectively prevents the feds from regulating cannabis at all.
The continued listing of cannabis as a “Schedule 1” controlled substance (the source of the federal prohibition) also hinders the provision of insurance and other financial services to cannabis enterprises operating legally under laws passed in nearly half the states since 2012, which legalize the recreational use of cannabis.
In the absence of federal action to clarify the legal status of cannabis, “we unfortunately see the illicit market-place continue to thrive,” says Patrick McManamon, cannabis practice leader of Cannasure, a subsidiary of One80 Intermediaries, a wholesale brokerage and specialty program manager. The cost of this, he adds, is borne by legal cannabis enterprises “who invest heavily to meet the strict demands of selling consumer-safe products,” as well as by consumers exposed to potentially harmful products and states who lose tax revenue.
“Federal legalization would allow the industry more access to financing,” says Lee Woodruff, vice president of business development, Midwest region, Jencap Group. “[The federal ban] is definitely something that’s holding the cannabis market back. People are hesitating to invest in the business.”
The federal ban on cannabis directly affects insurance markets, according to Jennie Carr, vice president of commercial brokerage for Arlington/Roe. “Many insurers are reluctant to offer insurance to cannabis businesses for a variety of reasons,” she says, “not the least of which is the chance that an insurance sale might be considered an illegal monetary transaction.
“Carriers are also concerned about legal complications and exposures arising from differences between state and federal law,” sheadds. “State cannabis policies are also in-consistent among jurisdictions. We encourage legislators to adopt an approach to cannabis liberalization that addresses these inconsistencies.”
Unless and until cannabis is removed from Schedule 1, there can be no interstate market for cannabis products, says Charles V. Pyfrom, chief marketing officer, CannGen Insurance. As a result, unsold surpluses of cannabis pile up within state borders.
“You have to sell the product in the state where you grow it, so each state controls its own cannabis economy,” Woodruff explains. “A lot of states have an oversupply, because most states are not capping licenses for cultivators.”
“The over-supply drives down prices for flower,” Woodruff adds. According to him, prices for cannabis flower (the leafy part of the plant) in many states are down by about two-thirds in the past two years.
“Operations and market conditions vary greatly from state to state,” says Carrie Heinlein, vice president for commercial binding and under-writing team leader for Arlington/Roe. “In states such as Colorado, Washington, and Oregon, where the industry has matured, there are markets that are showing signs of saturation and even decline. In Midwestern states like Michigan, we’ve seen the cost per pound decrease as they experience the initial phase of market saturation.
“As states issue more and more licenses, oversupply could become an issue, especially for small operations, and may lead to more mergers and acquisitions in the sector.”
New ways to partake
While market growth may be constrained by state borders and federal law, the cannabis business is rapidly expanding the range of its product offerings.
“The market is also seeing a host of new products fueled by innovation and research dollars,” says Heinlein. In a development analogous to craft breweries and distilleries, Heinlein sees craft cannabis producers sponsoring “cannabis consumption lounges” as a new form of hospitality enterprise.
“There is definitely strong growth in cannabis edibles and especially in cannabis-infused beverages,” says Pyfrom, who notes that new, more refined ways of partaking in cannabis appeal to a class of users who seek to avoid both the potential health effects and the “stigma,” as he puts it, of smoking marijuana.
While innovation in cannabis use advances at a brisk pace, progress is much slower in determining the effects of cannabis on users, both in the short term and in the long run.
“There’s no reliable sobriety test” for cannabis use, says Woodruff. As a result, he adds, cannabis dispensaries and lounges are still working out how to provide good service to customers without getting them inebriated.
So far, there is no indication that cannabis use leads to significantly greater vehicle or workplace losses, according to McManamon. “There hasn’t been a spike in claims or in the cost of insurance due to cannabis usage on the job,” he says. “There will be increased attention to this as the market matures, and testing becomes more reliable, and if accidents become more common. But for now, those types of claims are not among the top attention grabbers in our business.”
“There are indications that cannabis is not as impairing as alcohol, but traces of it remain in your system longer,” says Pyfrom. Thus, while cannabis use may not contribute to auto or workplace accidents as often as alcohol use might, in the wake of an accident, traces of cannabis will remain after traces of alcohol would be gone. Thus, the time period for cannabis-related liability exposure is longer than that for alcohol.
“[O]versupply could become an issue, especially for small operations,
and may lead to more mergers … in the sector.”
Vice President, Commercial Binding and
Underwriting Team Leader
Health hazard exclusions
A potentially huge liability exposure for cannabis enterprises is for bodily injury to consumers who contract illnesses from long-term regular use of cannabis, a topic about which much remains unknown.
To cite one example of research into the health effects of cannabis, a study released in November 2022 and published in Radiology found that emphysema and inflammation of air-ways were more common in marijuana smokers than in comparative samples of nonsmokers and tobacco-only smokers. While the study suggests that smoking marijuana may be more harmful than generally considered, the study addresses only the smoking of cannabis.
For cannabis enterprises and their insurance providers, uncertainty about the health effects of cannabis leads to the inclusion of “health hazard exclusions” in virtually every general liability policy covering a cannabis operation.
Those exclusions are designed to protect insurance carriers from open-ended exposure for chronic diseases later discovered to result from cannabis use, the type of claims that have inundated tobacco companies and some of their insurers.
While that’s to be expected, Woodruff advises agents and brokers to be alert to how extensively a health hazard exclusion is applied under a policy.
“Most polices have some sort of exclusion for harm to the health of users,” he says, “but some exclusions are softer and may cover immediate medical expenses from a bad product, while other, harder ones may be used to avoid what should be valid claims for sudden and accidental harm.”
The ambiguous legal status of cannabis in the United States (legal under some state laws, illegal under others, and technically illegal under federal law) complicates the acquisition of adequate levels of property insurance for the unique mix of first-party expo-sures faced by cannabis enterprises.
According to Woodruff, theft accounts for the highest frequency of losses for cannabis businesses, but the greatest loss severities result from fires stemming from the lighting used in the cultivation and processing of plants.
“Among the largest and most severe claims we’re seeing are fire losses from grow lights,” says McManamon. “We are seeing issues where bulbs are mismatched with defective ballasts that fail over time, often due to a lack of maintenance.”
The process of extracting CBD oil (the substance that causes cannabis’s effect) involves intense heat and can be very volatile, according to Heinlein.
“One of the most common methods utilizes butane, a highly flammable gas that can ignite easily through contact with static electricity, open flames, or other ignition sources,” she says. In response, some insurers writing property coverage for cannabis businesses will add a warranty that extraction will be done only within closed vessels.
Carriers are also demanding rigorous adherence to electrical safety standards, Heinlein says.
“A system must be designed to handle the considerable electrical loads required for cultivation and processing,” she says. “Some of the common problems we see are use of extension cords and other equipment not approved by Under-writers Laboratories, and changing out circuit breakers to prevent tripping of the breaker, which causes wires to overheat.
“As it is, cannabis growing operations use high intensity lighting whose bulbs can reach over 1,000 degrees Fahrenheit and cause chemicals stored nearby to combust.”
As for high-frequency theft losses, Pyfrom advises cannabis merchants that “like a jewelry store, don’t keep your merchandise on display after closing.” At the end of each business day, he says, cannabis products should be removed from view and locked away for safe keeping.
That kind of safekeeping will also protect cannabis inventory against the ravages of windstorms and wildfires, perils that Pyfrom says other carriers are increasingly excluding from can-nabis property coverage.
Where there’s uncertainty there’s also opportunity, says Carr, regarding the cannabis insurance market. “The need for coverage is often met by E&S carriers due to their underwriting expertise and their ability to create effective products,” she says. “As a managing general agent and wholesale brokerage, we have been able to find solutions to work within this rapidly evolving landscape.
“As a broker, it is exciting to see interest in coverage enhancements, higher limits, and additional lines of coverage.”
Cannasure also reports indications of a softening of the insurance market for cannabis enterprises.
“Additional carrier capacity and a better understanding of the risks has helped start a reduction in rates,” McManamon says. “Today, with nearly 10 years of underwriting data and experience, underwriters are able to better price individual risks.”
“The market with its limitations has come a long way,” says Woodruff, “and federal legalization would open it up to new carriers.
“It’s still difficult to work in this space but it’s better than it’s ever been.”
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Joseph S. Harrington, CPCU, is an independent business writer specializing in property and casualty insurance cover-ages and operations. For 21 years, Joe was the communications director for the American Association of Insurance Services (AAIS), a P-C advisory organization. Prior to that, Joe worked in journalism and as a reporter and editor in financial services.