The cannabis industry is maturing rapidly. The global market was valued at $17.8 billion in 2021 and is expected to expand at a compound annual growth rate (CAGR) of 25.3% in the coming years, projected to reach a valuation of $134.4 billion by 2030.
Despite the market size and opportunity, cannabis companies face ongoing challenges and affordability issues when securing directors and officers (D&O) insurance. Because cannabis is still illegal at the federal level, many major insurers refuse to write D&O insurance in the cannabis industry. Those that offer it are doing so with notable exclusions, high premiums and steep retentions.
With the amount of activity in the market, D&O is the single most important policy a cannabis business can have—it protects executives, board members, personal assets, balance sheets and reputations. While there is hope for a softer market in the years ahead, companies must understand current D&O market challenges and implement necessary risk management safeguards.
Benefits of D&O Coverage for the Cannabis Industry
D&O policies are a must for those operating within the cannabis industry, offering critical protection and supporting strategic business initiatives, including:
Protection of personal assets: D&O coverage protects the personal assets of board members and management in the event they are sued for their management or mismanagement of the company. This is especially valuable when the company is either unwilling or unable to indemnify managers. Without a D&O policy in place, business leaders would have to fund their own defense and settlement costs, which could be substantial. This is of notable concern within the cannabis industry due to federal regulations around cannabis, which heighten legal risk. Some carriers write D&O policies with regulatory exclusions, but not all.
Derivative action, books and records demands: As a precursor to derivative action claim, cannabis companies will often be presented with a books and records demand, which requires the business to put forth the records of all the board member meetings. This can be an incredibly time-consuming and expensive process. D&O policies recently expanded coverage to supplement books and records demands costs that businesses would historically have to fund on their own.
Reputational protection: If a cannabis company is sued, especially in securities class action suit, it will need to perform significant damage control or risk reputational harm. Many D&O policies provide sub-limits that cover the hiring of a public relations firm and other expenses associated with mitigating reputational damage.
Bankruptcy risk mitigation: If a cannabis company goes into bankruptcy and is presented with a derivative lawsuit, which is a non-indemnifiable loss, D&O coverage can mitigate the loss by offsetting defense costs.
Management and board member attraction: As cannabis companies grow in size, scale and sophistication, they require a much higher level of expertise and experience from board members. To effectively attract and retain high-value board members and management, companies must have D&O policies in place. Many executives will refuse to join companies without adequate D&O policies.
Merger and acquisition support: Not having D&O coverage could also prevent an acquisition from going through. It is one of the first things buyers look for before entering into a deal.
Challenges Within the D&O Cannabis Market
After a prolonged soft insurance market highlighted by carriers experiencing deteriorating financial results and continued increased loss costs across numerous management liability lines of coverage (driven by public company D&O and cyber), D&O insurance has been in a hard market for the past few years, becoming more expensive across all industry sectors. Within the cannabis industry specifically, disgruntled investors sued business leaders for failing to deliver on growth and profitability promises, driving D&O coverage costs up further.
In addition, cannabis is still illegal at the federal level, which makes many carriers nervous. Many do not view the legal risk as being worth the premiums. Carriers that are actively offering D&O policies in the cannabis space are writing coverage conservatively, with regulatory exclusions that deny coverage if the federal government flags illegal behavior; and financial condition exclusions, which deny coverage in case of bankruptcy or financial impairment. Additionally, underwriters look closely at business operations, with some more willing to write D&O policies for companies that strictly sell CBD oil rather than companies selling THC products.
Banking also continues to be difficult for the cannabis industry. Some states have legalized cannabis, which allows companies to work with banks. However, federal regulations mean cannabis companies face more oversight and cost than non-cannabis businesses. This contributes to the lack of underwriting appetite among carriers. If a cannabis company is not in a strong financial position and does not have access to capital, the risk is greater for the insurer. Cannabis companies also are not permitted to go public on traditional markets—they have to go through the over-the-counter (OTC) exchange or trade in Canada—creating additional hurdles.
Transitioning to a Softening Market Ahead
After years of a hard market environment, the D&O and management liability space is beginning to transition. Many new carriers have entered the management liability space for cannabis and non-cannabis business (a combination of new insurance companies, existing insurance companies expanding their product offerings and managing general agents), bringing a lot of new capacity into the market. Existing carriers are still facing increased loss costs and the impact of COVID-19 and recent inflationary pressures are still unknown. Though we will not know with certainty which way the market is trending for at least another year, several factors could contribute to a softening of the market. These include:
Pending legislation: Two pieces of cannabis-related legislation, the SAFE Banking Act and the CLAIM Act, have been passed in the House of Representatives and are awaiting a Senate vote. The SAFE Act protects financial institutions from liability or regulatory action for doing business with cannabis companies. The CLAIM Act creates a safe harbor for insurers working with a cannabis-related business.
If either bill passes the Senate, it will have an enormous impact on the cannabis industry, spurring growth and radically increasing insurer appetite to write coverage in the space.
Even if the legal environment does not materially change at the federal level, the potential financial reward and opportunity within the multi-billion-dollar sector could soon outweigh the risk as insurers seek to maintain or increase revenue, prompting more carriers to enter the space.
Global market capacity: At the moment, Lloyd’s and Bermuda cannot legally cover cannabis. If that shifts, and Lloyd’s and Bermuda carriers are able to write companies in the cannabis space, the market will open up and carriers could change their tune and begin to insure cannabis more openly.
Risk Management Considerations
To secure and retain D&O insurance in the current market, cannabis companies must take extensive measures to present themselves as a high-quality risk. Businesses in the industry must be as transparent as possible about:
- Financials (forecasted revenue, cash on hand, earning history)
- How the product is created and protected
- How they are complying with state and federal laws and regulations (including the RICO Act)
Underwriters and brokers are also increasingly looking at investor decks when assessing a company’s risk level. They are more likely to offer coverage to cannabis businesses with proven track records and heavily experienced C-suite leadership.
As the cannabis and D&O markets continue to evolve, businesses should work closely with industry experts to navigate challenging conditions and lock in the coverage they need to alleviate risks and continue to prosper.