Financial lines carriers face big challenges in insuring cannabis business
This article was originally published in Insurance Day, 12 February 2020.
The legalisation of cannabis in certain parts of the world presents both big challenges and big opportunities for insurers.
A Lloyd’s market bulletin from August 2018 on the (then pending) legalisation of recreational cannabis in Canada concluded Part 7 of the Proceeds of Crime Act (POCA) should not engage where the activities underwritten are legal in the jurisdiction in which they are carried out. The bulletin gave reassurance to the London market to underwrite cannabis-related risks in Canada, but underwriters must still ensure they comply with local Canadian requirements.
The POCA is the UK’s principal anti-money laundering legislation and provides any individual making money from illegal activities can be prosecuted and the proceeds of such activities confiscated. Cannabis is only legal in the UK as a medicinal drug on prescription or as a cannabidoid, (that is, in its non-psychoactive form, CBD). Recreational use of the psychoactive THC compound remains illegal.
The legalisation of medical cannabis may lead to confusion among insureds, causing them to believe activities relating to medical cannabis in other countries are more or less “like for like” and it is therefore unnecessary to address potential liability under the POCA.
However, the UK’s regime only allows for a maximum THC content of 0.2% in medical cannabis and the approach taken in different jurisdictions varies. It is unclear as to how closely the jurisdiction needs to mirror the UK’s to avoid liability.
While coverage is therefore theoretically available for the activities of insureds providing financial or investment services in connection with cannabis companies or companies in those supply chains, the concern remains that individual investors in cannabis related products are nonetheless exposed to prosecution under the POCA.
Reporting to NCA
In practice, companies in the sector have adopted the approach of routinely submitting suspicious activity reports to the National Crime Agency (NCA) to obtain actual or deemed consent for proposed transactions. This does, however, lead to delay, which may endanger the viability of certain transactions or investments based on notoriously volatile share prices.
In the US, cannabis containing more than 0.3% THC remains illegal on a federal level for any use, while individual states have a patchwork approach. Many states have legalised recreational cannabis, but others have not – and there are differences in THC levels permitted in medical cannabis. In practice, there has been no federal enforcement to date with respect to legal state operations.
Federal arrests can occur and exposure can arise (whether knowingly or unknowingly) where part of a cannabis company’s supply chain extends out of state. Transportation of cannabis over state lines is illegal and grey areas arise where a company purchases production equipment and ships it through a state where it is illegal to possess such equipment without a licence from that state.
At federal level it is still illegal to provide banking or insurance services to cannabis companies. However, a bill to introduce the Secure and Fair Enforcement Banking Act (Safe Act) was introduced in May 2017 and is making its way from the House of Representatives to the Senate.
It is intended to protect financial institutions (including insurers) that choose to do business with cannabis companies in states where cannabis has been legalised, without the need to apply for permission to do so, as is required at present. The aim is to provide a regulated framework for financial institutions to work with state-legal cannabis-based businesses.
Whether the Safe Act will be passed by the Senate and, if so, when remains to be seen. The timeline has moved to this year but analysts believe it is unlikely a Republican-led Senate will pass cannabis-based legislation in an election year. The predictions are the act will almost certainly be put on ice until the new Congress arrives in 2021.
Despite the uncertainty, press reports say significant venture capital investments were made in start-up cannabis companies last year. Wall Street has produced varied estimates of between $50bn and $200bn in worldwide cannabis sales by 2030 but share prices of listed cannabis companies continue to be volatile.
Funds and other insureds providing services to investors, particularly private individuals, face a challenging and unpredictable market that is highly exposed to political and regulatory uncertainty across a host of jurisdictions. Issues such as the applicability of intellectual property laws to cannabis products are also being tested. In the short to medium term, potential claims arising from mismanagement and mis-selling continue to provide concern.
There is growing support for greater progress in regulation in relation to both THC and CBD. CBD products are flooding the high street, from health-enhancing supplements to beauty products, with little evidence for their claims and it is important for insurers to recognise there are still significant health concerns surrounding the use of cannabis.
The biggest concern remains general/product liability risks associated with cannabis in terms of potential harm to human health. We are seeing a rise in Canada and the US in e-cigarette or vaping product use-associated lung injury (EVALI) allegedly related to THC and links are being made between THC and the development of psychosis. The liabilities around edibles are also unknown territory.
The full extent of these risks is unlikely to be known for some time and may give rise to extensive litigation, especially in the US, where there is a strong class action culture. If this mirrored the scale of ongoing claims against opioid companies, where billions of dollars have been paid in settlements, this may prove a sizeable exposure for general liability insurers but also potentially involve directors’ and officers’ (D&O) insurers.
Commentary from the broker community in the US in particular suggests the availability of D&O insurance in the cannabis sector is sparse and rates are high, given the uncertainties surrounding the cannabis market and use. Some states are actively requesting insurers provide cover.
Cannabis suppliers, like any other supplier, naturally have a need for crime policies, particularly to cover cash in transit, albeit coverage may more usually be provided under property insurance.
As the need for coverage expands, there remains a large degree of uncertainty in the cannabis insurance sector as a result of the lack of data and underwriting experience, as well as the ever-changing legal landscape. The challenge for insurers is to maintain an accurate understanding of the legal position in relation to cannabis not only where they or insureds are headquartered, but wherever they do business.
Potential liability under the POCA cannot be taken lightly and may become a more prevalent issue. Insurers should continue to carefully vet the proposed activities of potential insureds and the due diligence procedures they have in place and ensure they understand the scope of risks being covered and consider additional conditions or appropriate exclusions if necessary.