Getting Into The Weeds On Insuring The Marijuana Industry

Declarations: The Coverage Opinions Interview – Vol. 3, Iss. 14 – October 6, 2014

With Doug Banfelder Of Premier Dispensary Insurance

A few months back there was an article in The Wall Street Journal called “The Pot Industry Puts On A Tie.” The story was about how, with marijuana now being legalized in more places, those involved (including some that were previously operating in the black market) need to confront a variety of business issues – some that all companies face and others unique to their industry. The article mentioned a seminar held in June, in Denver, in which 1,200 people came looking for answers to questions about banking and taxes and no doubt other business issues. But what grabbed my attention was that the seminar included a presentation called “Protecting Your Investment: Risk Management and Insurance for the Cannabis Industry.” After that I put on my to-do list: find out more about insurance issues concerning the marijuana industry.

The marijuana industry is big and projected to see extraordinary growth in the next few years. Everyone knows that Colorado and Washington state recently legalized marijuana for recreational use. But there is much more to it than just two states. Twenty-three states and D.C. have legalized marijuana for medical use in some form. And more states may soon be joining the medical and recreational lists. It is an active legislative and ballot issue in several states. As for the size of the marijuana industry in dollars, who knows. I saw statistics that were all over the board. The only thing the numbers had in common is that they were in the billions — and projected to be in the many more billions in the next few years.

Insurance broker Doug Banfelder, of Premier Southwest Insurance Group in Scottsdale, Arizona, and founder of its Premier Dispensary Insurance Division, specializes in placing coverage for various types of businesses involved in the marijuana industry. Doug was in fact a panelist on the insurance presentation at the Denver seminar. Doug was kind enough to speak with me about insurance and risk issues in the pot business and engage in a very informative Q&A, which is set forth below.

The 54 year old is new to the insurance industry, having joined it just four years ago, with the last three spent at Premier Dispensary. Doug’s background is in Arizona politics. But when his boss lost re-election he set out looking for a new career. Despite Doug’s recent entry into the insurance field, it was clear from speaking to him that he is a very quick study. He sounded like a 20-year veteran when explaining the various types of coverage, and related issues, concerning the marijuana industry. Doug’s many years in politics clearly compliments his role as a broker. The political process plays a large part in understanding the marijuana industry. Doug sensitivity to politics came through very clearly as he spoke to me about the future legalization landscape and various regulatory issues that come with legalization.

I read a lot about insurance issues concerning the marijuana industry in preparation for the piece. But nothing taught me more about the subject than my discussion with Doug and the Q&A that follows. There is now one fewer item on my to-do list

What are some misconceptions that people have of the marijuana industry and those involved?

Contrary to the marijuana stereotypes and imagines that often come to mind, the majority of cannabusiness entrepreneurs are everyday Americans. They are professionals that embody our nation’s can-do, risk-taking spirit. They see the business potential, are unfazed by the challenges, and, most critically, are unafraid to engage in a degree of civil disobedience, essentially telling the federal government by their actions that the war on marijuana has failed and that new public policy models are needed. These people embrace the idea that, in a free society, it is not only their prerogative but also a civic duty to agitate for changes to failed policies.

Despite the success of the reform movement in twenty three states and the District of Columbia, the bottom line for the foreseeable future remains this: all state-sanctioned cannabis possession, growing and distribution is still federally illegal. Proceed at your own risk.

What are the main aspects of the marijuana industry (e.g., dispensaries, growers, etc.) and what are the principal insurable risks faced by each?

The primary exposures for dispensaries are not much different than those faced by other retailers, such as theft by customers and employees, fire, weather-related and product liability. Strong-arm robberies are very rare: the robust security measures required by state regulators and carriers tend to make criminals seek softer targets (such as liquor stores).

Growers face these risks and more; a simple power outage, if prolonged, can cause the loss of a roomful of plants during sensitive phases of the growth cycle. Hundreds of thousands of dollars worth of plants can lose all value within just a few hours. Plants that pass a state-mandated lab test may still contain trace amounts of pesticides or mold, potentially exposing the entire chain of distribution – grower, test lab and retailer – to product liability suits.

Infusion and Extraction operations have their own risks. Infusing cannabis butter into food products can result in uneven dosing, creating the possibility of product liability claims that a too-strong serving either made a person sick or caused an anxiety attack, especially in a “naive” patient or recreational consumer (hello Maureen Dowd – Google it!). All standard food preparation best practices apply, of course, and the same goes for makers of lip balms, salves, breath strips, etc, etc.

Extraction operations pose fire and explosion hazards when butane or hexane are used. Super Critical CO2 extraction machines are safer but very expensive, with prices of up to $150,000 for a high end unit. For cultivators, professional third-party transport is not yet possible due to chain of custody regulations; in most states licensees must perform all wholesale deliveries. This is problematic from a public safety perspective, as a Master Grower is not likely to also be a security specialist.

Legal cannabis is a very capital-intensive industry, so proper Property coverage is vital. Many retailers aim for an upscale environment, employing furnishings such as glass and wood showcases and high end lighting fixtures to create a hip, comfortable vibe that helps conceal the facility’s extensive security measures – much more jewelry store than pawnshop or headshop.

Lessor’s Risk is another major consideration – the vast majority of carriers want nothing to do with a building housing a cannabis operation. A (very) few will provide policies for those with a dispensary tenant, provided the premises otherwise meets their usual underwriting guidelines. If the building will be home to a commercial cultivation, all bets are off – indoor agriculture poses too complex a set of risks for those who don’t know the industry.

This is a shame, really, as these operations – especially in states where production and distribution are tightly regulated means that every aspect of the operation, from security to electrical architecture to air filtration systems and more must be inspected and approved by the state before opening and are then subject to additional inspections, a level of regulation far exceeding that of nearly every other type of business. This intensive, state-performed risk management dramatically lowers the risk assumed by carriers. Fortunately for the cannabis industry, there are at present “just enough” carriers willing to write this business to make those leasing to cultivations fully insurable.

On the professional liability side there is coverage available for testing laboratories, Directors & Officers, cannabis business consultants, and medical malpractice for doctors performing patient evaluations. Security companies also pose huge challenges for so may reasons.

Are there any insurance requirements mandated by law?

In both MA and WA state, regulations require General and Product liability with $1,000,000 limits. The policies must name the state as an Additional Insured (this particular requirement is in effect in IL also). Additionally, WA policies must contain Primary Wording. A director of the WA State Liquor Control Board reached out to me as they were contemplating insurance requirements. We had a good conversation and I sent them a copy of our application form.  Regulations addressing carrier concerns is a win-win.

Some jurisdictions require either performance bonds or escrow accounts. As just one example, CT and IL mandate $2,000,000 performance bonds for cultivations; these are exceedingly difficult to source. The high dollar value aggravates an underwriter’s primary concern: the ever-present possibility that the federal government could do an abrupt about-face and shut these state programs down. While seemingly less and less likely as each day goes by and another state adopts a program, this threat cannot be ignored.

Who are the main insurers in the industry and how long have they been involved?

The Lloyds of London program began in 1998 when a California underwriter realized, two years after that state passed the nation’s first medical marijuana law, that there were no markets for this new risk. This program is very comprehensive and continues to evolve rapidly in response to industry needs.

Other programs exist, offered from Essex, James River, Kinsdale and Scottsdale. These programs have a variety of differences, such as some only being offered in medical states and not serving the recreational market. In some cases, in order to obtain GL, an insured must also carry a professional policy. A carrier might write GL and Products, but no property, so an agent has to source a monoline property to put a package together. Some programs lack desirable endorsements.

Overall I’m seeing a few carriers “dipping their toe” into these mostly uncharted waters, offering limited coverages to build their reserves and actuarials until they understand the industry well enough to begin offering stronger policies with more refined pricing.

What are the biggest challenges faced by marijuana underwriters and what is some of the important information sought by an insurer when underwriting a dispensary and grower?

Being able to see past the stigmatization is key to properly assessing the exposure. Due to cannabis’ history as a black market commodity, many people associate the product with criminal activity, triggering a whole range of negative perceptions. Society’s experience has proven, however, that the most dangerous thing about marijuana is the fact that it’s illegal – we have made it more dangerous to be caught with the substance than to actually use it. As with any other risk, underwriters need to know the industry to understand the risk profile. The agent must be able to fully and accurately convey the true nature of the client’s operations to underwriting so that they may make a clear assessment based on actual rather than perceived risks.

Can you discuss some challenges that come from the industry going from illegal to legal and regulated.

Hands down the lack of banking is number one. What other aboveground $2 billion industry doesn’t have access to checking and savings accounts? Credit card issuers won’t knowingly serve the legal cannabis industry either. This is why so many dispensaries do all their transactions in cash. In fact, many keep an ATM in the reception area. All this cash – held by the customer, kept in the merchant’s till, counted by hand, stored on-site until taken away, and used to pay as many bills as possible – including payroll, even – is obviously a source of great concern to carriers, regulators, and tax authorities.

Location of operations is another tough nut to crack.  In Denver there were no zoning regulations early on, resulting in the dense clustering of dispensaries.  Neighborhoods typically react badly to any land use perceived as adverse to the community’s health and well-being, even more so when they feel under siege by a particular industry.  We’ve seen this play out across the country, with the implementation of moratoria of six months to a year being common; other communities have enacted outright bans.  Washington state’s attorney general issued an opinion that municipalities could ban these facilities under I-502, the state’s enabling legislation – but others disagree.  This and related issues could well end up in the state supreme court.

Some jurisdictions allow dispensaries but zone them into industrial areas; less than ideal for safe, convenient customer access. Even cultivations, commercial kitchens and extraction operations, as anonymous as other industrial uses, can run into resistance. One client had a nearby property owner protest their use permit, alleging that the presence of a cultivation next to his building would lower his property values, though he offered no supporting data. I was happy to testify that the insurability of these operations, relatively low claims ratios and reasonable rates demonstrates that his fears were unfounded. The hearing officer approved the permit.

What would the reaction be if you approached a large P&C carrier (not involved in the marijuana industry) and asked to place CGL coverage for a dispensary?

You mean once they’ve stopped laughing? Although many underwriters I speak with see where the legalization trend is going and are not personally opposed, management at the vast majority of carriers have zero interest in this industry. I’d wager that 99.9% of admitteds and 98.9% of E&S carriers are definitely not a market for any sort of cannabis-related operation.

The marijuana industry is very regulated.  What are some of the key regulations that benefit insurers by minimizing risks?

When I first saw the Lloyd’s GL application I was struck by how closely its safety and security requirements paralleled those of the Arizona Department of Health Services, our state’s regulatory agency. This has been the case with nearly every state to come online since then. Key regs generally include a Central Station Alarm connected to all doors and windows; minimum safe requirements; having a reception area or double entrance; access to the showroom controlled by a buzz-in door; cameras trained on every doorway and window, safe or vault and at the point of sale, and many other strategies to prevent theft and diversion.

State regulations require a full range of policy and procedures manuals, often including written product recall plans, loss prevention measures, and a product quality control program. Other requirements can come from counties or municipalities, such as bulletproof glass inside dispensaries, for example. I find this interesting, as such measures are not required of pharmacies or liquor stores in most neighborhoods. One commodity or another – what is the difference, really?

What are some challenges to being a broker in the marijuana industry that are not faced by brokers writing P&C insurance for more traditional businesses?  Can you provide an example.

With traditional businesses the name of a given enterprise doesn’t raise suspicion! In the cannabis industry business names can be very telling: “herbal” this, “green” that, “high” something, “compassionate” care, “canna” this or that – all of which can set off alarm bells in underwriters’ minds. So right off the bat you’re having to explain the nature of the business. I’m ok with this, however, as I believe in full disclosure, all the time – my markets know what the likely topic of conversation is when they see my call coming in.

Even when a prospect’s business isn’t directly related to the cannabis industry, the mere whiff of an association can cause issues. Case in point: a client needed an office BOP to satisfy the lease requirement for a space he was renting. He has two businesses; one a dispensary, the other a bit unusual but fully legal and comparatively mainstream. He simply wanted a place to work that was away from everything and everyone. Should be easy, right? Not so fast. Underwriters from three different admitted carriers wanted to know what the other businesses were. I told them, explaining that each was fully insured, and yet was still declined by two of the three.

This challenge extends to those who will never even touch the plant. For example, a magazine  publisher who specializes in niche publications for a variety of industries added a B2B magazine for the cannabis industry – and their carrier cancelled the policy!

For agents the learning curve for this industry is significant, and so is the opportunity cost; in the time I spent sourcing a manuscript policy for a security company, or in another case persuading an underwriter to provide product liability for a marijuana vending machine distributor, I could have written plenty of other business.

Fascinating and frustrating in nearly equal measure, insuring the cannabis industry takes creativity, patience, a greater than normal level of risk tolerance, and the desire to make a difference.

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