November 21, 2018

Cannabis Industry, Risks and Opportunities for the Insurance World

With the newly legitimized cannabis market, the insurance industry must adapt to a myriad of new players.

Cannabis legalization represents an important opportunity for new insurance business as an entire industry develops along with its full slate of coverage needs.

The dam has burst. Canada’s long-awaited legalization of cannabis has finally arrived and, as expected, is experiencing inevitable growing pains. Long lines, supply chain shortfalls, health advisories, unclear investment structures, border troubles, policing concerns, and intergovernmental relations have all made headlines in recent weeks as the nation inhales the new legal landscape.

New Players in the Industry

Like many levels of the Canadian economy, the insurance industry must adapt to a myriad of new players rushing to fill gaps in this newly legitimized market. There are a variety of risks and coverage needs to be met — from those of governmental institutions and large retailers to small independent businesses.

Many of these will fit seamlessly into existing structures and will not radically change well-understood risks. Small to medium-sized businesses will continue to require EPL coverage. Newly employed workers in the cannabis industry will need standard benefits and health insurance programs. And government institutions will continue to need tailored liability coverage. In these areas, legalization should not cause seismic shocks.

Combining the Risks of Different Insurance Markets

More significant is the impact it will have on product liability and D&O risks. Comparisons are often made between legalized recreational cannabis and the alcohol and tobacco industries in respect of social impact and control. We are of the view, however, that the risks and insurance needs of the industry are more in line with those of the parapharmaceutical industry (centered on nutritional supplements, vitamins, etc.), in an environment that resembles the "gold rush" frontier.

Cannabis producers already face similar product liability and recall issues as parapharmaceutical companies (see, for example, the suit against Organigram). What we are witnessing is a perfect storm of evolving regulation, a production supply chain that was largely operating underground until only recently, and market demand that has overwhelmed the current legitimate supply.

Vacillating Regulatory Standards

As the market attracts investment and new players, licensing, manufacturing, and quality control processes will have to adapt to meet regulatory standards that are themselves in flux.

What’s more, regulators must be seen as strong enforcers of the new regime’s standards.  It’s part of the political bargain justifying the legalization of a former social taboo and health concern. In this context, traditional pharmaceutical producers, with large deductibles and existing insurance relationships, will be adept at mitigating risk and meeting regulations such as THC levels per delivery method, standardized testing, labeling, and transport requirements.

Smaller producers, however, lack the existing infrastructure and regulatory experience and may not be so adept at handling their product liability risks. Even so, they play an important role in filling supply shortfalls. Coverage wordings and premiums will have to be adapted accordingly as the emerging product liability risks become better understood and predictable with time.

On the D&O front, we anticipate growing risks concerning cross-border and financing issues. For now, it is clear that our largest trading partner to the South has not yet fully fleshed out its response to handling cross-border movement and the interests of Canadian nationals involved in the industry. The risk is that Canadian D&Os operating in a fully regulated industry on one side of the border will be treated as drug traffickers on the other.

Finances Closely Examined

Also, we anticipate growing regulatory scrutiny towards the corporate and finance structure behind new players in the Canadian cannabis market. One of the marquee policy goals of legalization was to dislodge criminal involvement in cannabis production and money laundering. As the structure of cannabis financing becomes more widely reported, we can expect hearing about offshore investments from known tax havens or unclear trust beneficiaries holding interests in Canadian entities. D&Os risk facing the brunt of potential liability and regulatory countermeasures.

Finally, as the recent securities class action filed against Cronos Group in New York demonstrates, piecemeal financial disclosures in a gold rush market can quickly lead to claims. Insurers will have to be cautious to tailor and clearly delineate the scope of D&O coverage accordingly, especially for small- and medium-sized producers, given that the risks facing newly minted D&O in the cannabis industry remain to be fully defined at this early stage.     

Cannabis legalization represents an important opportunity for new insurance business as an entire industry develops along with its full slate of coverage needs. Insurers must wade into these waters with some degree of caution, however, as the inherent underwriting risks have yet to be fully developed. Perhaps it is a good time to take stock, exhale, and see where Canada’s experiment with cannabis legalization takes us.