Legalized Marijuana: Opportunity or Time Bomb?

The number of unknowns surrounding the gradual legalization of marijuana across the U.S. far outweighs what insurers currently understand about this enterprise. For an industry that relies heavily on actuarial data to assess risk, this new venture provides little information on which to base coverage decisions or risk management strategies.

Just trying to find growth projections illustrates how much is unknown about the legalized marijuana industry. Grand View Research estimates that the global legal market is expected to reach $146 billion by 2025. The company also predicts that medical marijuana will reach an estimated value of $100 billion by 2025. Contrast these numbers with data from Arcview Market Research and BDS Analytics, which predict that spending on legal cannabis is anticipated to reach $57 billion worldwide by 2027. New Frontier Data, which describes itself as an authority on data for the cannabis industry, predicts that the legal cannabis market will grow to $25 billion by 2025. The greatest opportunity for growth is believed to be in the area of recreational use, which is anticipated to expand 67% by 2025.

There is a famous adage, “Follow the money,” and that’s particularly true in the case of legalized marijuana and hemp products. With 33 states, Guam, Puerto Rico and the District of Columbia legalizing some form of medical marijuana, and 10 states plus the District of Columbia adopting laws that allow its use recreationally, it is well beyond time for the insurance industry to consider what type of impact legalization will have on the various lines of business.

“Cannabis is not a new exposure,” explains Andrew Holmes, chief underwriting officer for UK-based CFC Underwriting, “but it’s the extent that it’s being legalized and decriminalized that creates new exposures for companies.”

With marijuana federally legal now in Canada and increasing its footprint across Europe, Holmes sees it as an emerging risk for insurers. “We need to understand the exposures from legal cannabis,” he says.

A challenge for insurers is the fact that the U.S. Drug Enforcement Administration classifies marijuana as a Schedule 1 drug, making its use or sale illegal at the federal level. Insurance companies, like banks, are subject to federal regulations, which pose risks to the entities providing services or collecting payments associated with marijuana products. Legalizing the use and sale of marijuana at the state level has created myriad rules and regulations that vary from state to state.

Identifying the real impacts of legalization

In an effort to connect the dots in a way that politicians, entrepreneurs and the general public have not, consider how these lines of insurance could be affected: auto (personal and commercial), property & casualty, commercial general liability, workers’ compensation, directors & officers liability, cyber, product liability, health and life.

Auto: Does legalization actually increase the number of auto accidents or not? Information from preliminary studies shows a modest increase; however, these numbers could also be due to a larger number of drivers on the road as unemployment rates and gas prices dropped. A roadside test is still not available to determine whether a driver is operating a vehicle under the influence of marijuana. A saliva test can confirm that a driver recently used marijuana, but not whether the driver is under the influence. In addition, combining alcohol and other drugs (legal or illegal) with marijuana increases the way it affects drivers and could contribute to a driver’s impairment.

Evidence shows that drivers under the influence of marijuana tend to drive more slowly and allow greater following distances between vehicles. They have fewer lane departures and change lanes less frequently. However, drivers under the influence of alcohol tend to be more aggressive, driving faster and frequently changing lanes or drifting out of their lane.

Tim Grant, senior director of underwriting, auto, for LexisNexis says there is still limited data for insurers to utilize regarding the impact of drugged driving and the company is collecting data surrounding this issue. He finds that carriers usually don’t exclude coverage for accidents involving driving under the influence; however, it may affect liability coverage for third parties. “The frequency of claims is higher than for sober drivers and in states where marijuana is not legal,” he adds. “Carriers are exposed to greater levels of risk and have to build that into their processes and underwriting.”

Property & casualty: Claims in this area could arise from incidents involving growing operations (for example, fires due to manufacturing processes, floods or environmental issues), theft, vandalism or damage, and other property-related claims. “For marijuana to grow, you need humidity, and the way you create the perfect growing environment is to artificially create the humidity and not allow it to leave the premises,” details William Mauro, director of commercial casualty product development at ISO. “This creates a mold exposure. In looking at the premises, it could lead to problems with the structure such as mold inside the walls from the operation and contamination of the product.” Creating the “warmth and sun” the product needs within the confines of a structure could result in real fire concerns because of indoor growing operations, continues Mauro.

In addition, plants need carbon dioxide to grow and it is pumped into the grow houses. “This creates a hazardous condition for humans operating in these environments,” says Mauro. “Dangerous gases intentionally involved in the operation could be an issue.”

Commercial general liability: Marijuana-related businesses have exposures similar to other commercial enterprises, but several are unique to these companies. “Since we’re talking about a plant, there is an issue with insect infestations,” warns Mauro. “Pesticides have been used for marijuana operations and could be dangerous to human beings.” The individual states are creating guidelines regarding the use of pesticides in these enterprises.

Ian Stewart, a partner with the Los Angeles office of national law firm Wilson Elser, says he has seen business disputes and unfair competition claims involving mislabeled products or items that were incorrectly advertised. “Each state has its own market regulations. The regulations cover the same things and the licenses are generally similar. However, each state has the same key points that must be followed.”

Workers’ compensation: There are multiple issues surrounding workers’ compensation: Should insurers pay for medical marijuana? If they do pay, how long should they continue to cover this expense? How does an insurer determine efficacy for an injured worker? If an employer has a zero-tolerance policy for illegal (or even legal) drugs, how does the medical use of marijuana affect that policy? What are the legal repercussions for terminating an employee who tests positive for marijuana?

Teresa Bartlett, M.D., senior medical officer at Sedgwick, explains that physicians can’t prescribe cannabis, they can only recommend it because they think a patient qualifies under state guidelines. She says the general opinion is that marijuana is not good for pain relief, and that there are other legal drugs containing some aspects of cannabidiol (CBD) that could be prescribed.

When it comes to covering the cost of medical marijuana, Bartlett shares some concerns. “Medicinal marijuana is not standardized; we don’t know the quantity, dosage or intensity of what’s being ingested. We don’t know what a person is getting or what we’re paying for.” In addition, marijuana purchases are usually on a cash-only basis, which can make it difficult to track purchases.

Workers’ comp issues also affect employees of cannabis-related companies. David Geller, emerging issues senior analyst with Verisk explains that there are risks of explosions and fire, and chemical exposures to pesticides and fungicides that could become issues later on down the line. Then there are issues involving drug testing. “Testing employees is difficult, but necessary if they don’t want someone working under the influence.” Workers’ comp claims for employees generally include cutting accidents suffered during the preparation phase or exposure to chemicals used during processing.

Directors & officers liability – Directors and officers of any marijuana business face the same liabilities as those in other commercial enterprises, but they could have greater exposures for product liability and other risks.

Cyber – In addition to protecting a purchaser’s personally identifiable information, many customers are purchasing marijuana products online, which gives rise to data breach exposures, said Holmes. Owners of smaller enterprises are already at risk because they may not understand the cyber risks or have the systems in place to protect their websites or customer information from being hacked.

Product liability – Because each state establishes its own guidelines and regulations concerning the sale and manufacture of marijuana-related products, they vary significantly. Companies that manufacture products frequently purchase supplies from growers and suppliers. The products come in different strengths and there are no federal regulations concerning labeling, so some products may not be appropriately identified for specific uses or have accurate information about the percentages of tetrahydrocannabinol (THC) and CBD they contain.

Health – A new study finds that babies exposed to cannabis in utero late in pregnancy were 82% more likely to experience a low birth weight, 79% were more likely to be born early, and 43% were more likely to spend time in the neonatal intensive care unit. In addition, the THC found in marijuana can be absorbed in a mother’s breast milk and then passed onto a nursing infant.

The Centers for Disease Control and Prevention (CDC) finds that frequent use of marijuana can lead to addiction (approximately 1 in 10 people), but says the risks may vary depending on how it is used. Although smoking can produce an almost immediate “high,” edibles take longer to digest and produce an effect, which can lead to individuals consuming more marijuana than they think, so it affects them sooner. Marijuana affects brain development, so individuals who begin using it in their teens may see an impact on their learning functions, attention and memory as their brains are still maturing.

Life –Insurers generally conduct physicals for individuals purchasing life insurance, so any recent use of marijuana would be detected, and the insurer may consider it a risk factor for coverage. There have been no long-term studies conducted to determine the effect of prolonged marijuana use on life expectancy, however, there does seem to be increasing evidence that individuals who start using marijuana in their youth develop memory issues, and can damage their bronchial passages and lungs. Regular marijuana use can also increase the risk of heart attacks and strokes in individuals of all ages according to research by the Journal of the American Heart Association.

Myth busting

There are many misconceptions about those involved in growing, manufacturing and selling legalized cannabis. Some might believe that owners are more like the characters portrayed in the old Cheech and Chong movies, but nothing could be further from the truth.

Others think these companies are poorly run and have haphazard business models. In actuality, many of these owners graduated from college with business degrees and worked in other industries before entering the world of legalized cannabis. “We have a new group of entrepreneurs who operate differently from businesses started just five years ago,” shares Patrick McManamon, CEO of Cannasure, which specializes in providing insurance products for this market. “It is a highly competitive industry and there is a belief that they are making millions and millions. In reality, compliance with state regulations eats into the profit margin.”

Eduardo Provencio, general counsel for Mary’s Brands, which manufactures marijuana and hemp-derived products, concurs. “This industry is maturing pretty quickly. You see a lot more suits and blazers than tie-dye and dreadlocks. A lot of smart people are getting into this space.” He shared that the company has spent the last year bringing in people with operations and sales experience outside the cannabis industry. “New executives come in with experience from outside businesses that has to be adapted to meet federal or state regulations.”

Another myth is that legalization is somehow making cannabis more popular and causing it to proliferate. Not so, says Morgan Fox, media relations director for the National Cannabis Industry Association. “It was already popular and confined to an illicit market and people’s private lives. Now it’s controlled by legitimate businesses.”

He agrees that they’re seeing some increase in consumption by adults where cannabis is legalized. “We see older Americans trying it for the first time because the stigma has been removed, or they’re finding it useful for medical purposes and pain management.”

Seeing the big picture

Currently, there are approximately two dozen carriers offering various types of coverage to marijuana-related businesses. What are some of the specific risks, challenges and concerns for cultivators, manufacturers and dispensaries that require coverage? Here is a look at one enterprise with multiple components. Each division of the company has different levels and types of risk.

• Mary’s Brands is the colloquial term the companies used to describe the multiple entities and business lines. Founded in 2012, the company entered the medical marijuana product market in 2013. The co-founders wanted to pursue the medicinal properties of the plant, explains Provencio. The standard users for their products are usually older, first-time users, some “soccer moms” and others who are more discrete users/purchasers. Their flagship product is a transdermal patch used for pain management.

• MM Technology Holdings, licensed in Delaware, is a technology holding company that houses all of the company’s trademarks, and product technology, which are licensed to other affiliated entities of the company.

• Mary’s Medicinals is the locally owned entity that houses the company’s plant-touching products and is licensed in Colorado. It holds the recreational and medicinal-infused product state licenses, and manufactures and sells products under the Mary’s Medicinals brand name to dispensaries, who in turn sell the products to consumers.

• Mary’s Nutritionals is the entity that produces industrial hemp-derived products under the Mary’s Nutritionals, Mary’s Methods, and Mary’s Tails (a hemp product line for pets) brand names. Unlike Mary’s Medicinals products which must adhere to the stringent state marijuana regulatory regime, Mary’s Nutritionals products are produced and distributed nationally and internationally.

• Mary’s Operations is not a plant-touching entity but it supplies the non-marijuana and non-hemp components (such as the patch the marijuana or hemp product goes on) for the marijuana and hemp-product businesses.

• Mary’s Management serves as an employee-leasing entity, which provides employees for many of the company’s various affiliates.

Provencio says the company works with a broker that specializes in cannabis insurance, and finding insurers is still a challenge. The company’s premiums are generally higher than those paid by standard commercial businesses because there are fewer carriers with which to work. Some of their risks include auto liability because they have drivers who deliver their products, product liability and employee theft because they are a cash-heavy business. They use an armored car service to transfer their funds to a local credit union.

The company carries general liability, product liability and medical expense for its hemp-derived businesses, product loss, employee theft, and directors & officers liability for their leadership team.

“The problem is that there are limited options for coverage,” explains Provencio. “We really have to look at all of the exclusions and endorsements to make sure we have the coverage we need, especially with the federal regulations prohibiting protections for illegal business activities.”

He says that although the premiums are high, getting coverage has been a relatively smooth process for the company. “A lot of coverage is emerging in the product space,” he adds.

Because the company is only a manufacturer and not a cultivator, they purchase the raw materials (flowers and plant material) and extract it themselves to turn it into an oil used in their products. If needed, they will also purchase oils from suppliers. However, they’re not a retailer, so their products are only sold to dispensaries.

All incoming materials and finished products are tested in-house before they’re sent to a dispensary. “We have a science team who tests products for potency, pesticides and any other requirements the state may have,” shares Provencio. The company also sends its products out for third-party testing as required by state law.

There are numerous products available for sale at dispensaries, including transdermal patches; capsules and tablets; lip balms; lotions, creams and balms; elixirs; products for smoking, vaping and dabbing; edibles; and many more. “It’s amazing how creative the industry has become,” marvels Provencio. “It’s the craft beer of this day and age.”

The products have various levels of THC and CBD in them. A review of the products on the website for a Timonium, Maryland-based dispensary called Curio Wellness shows the percentages of THC and CBD in their products, with levels of 200%, 1000%, 1400%, 3000% and 5000% for THC or CBD.

Curio declined to be interviewed for this article, but it was difficult to find an explanation of how any product could contain more than 100% of these ingredients. “That is the whole issue. Since there is no standardized measure of THC, what is the right amount of intensity over a certain period of time?” asks Bartlett. “Each product has a different quantity and intensity. It’s hard to tell how long it impairs someone. It stays in the body for 30 days, although the impairment and intoxication decrease over time.”

Another concern is that people who work in the dispensaries may not know about the products they sell, the ingestion rates, how it will affect a user, or how long it stays in someone’s system.

For insurers who may be forced by a state to pay for medical marijuana, the question becomes: How long do we continue paying? Bartlett says there is no clinical research to suggest a duration for treatment. “It’s not an FDA-approved drug where you know the side effects, efficacy and so on. Is it a lifelong commitment for the carrier to pay it forever? We know that muscle relaxers are good for 10-14 days and then the efficacy wears off. This doesn’t have any efficacy, so how do you get out from under it?”

Insurance coverage and regulations

The conflict between federal and state regulations continues to be an issue for carriers, financial institutions and even the business owners themselves.

Cannasure’s McManamon says they have seen an influx of carriers into the market since 2017, and he finds “there are several hundred million dollars of premium out there for carriers.” Many of those offering coverage are startups focusing specifically on this industry. However, marijuana businesses that can’t afford or obtain coverage simply operate without it.

Fox indicates that they’re “starting to see more boutique companies that are creating products. They see the opportunity, value and progress being made to regulate the product, and they want to be a part of it.” He also predicts that there will be more large carriers coming into the market. “Those who come in will see tremendous benefit.”

Stewart agrees that there are opportunities for carriers, and he too expects several large commercial insurers to enter the market by the end of the year. Other carriers are not so sure.

Lloyds of London will only provide insurance at a country level and will not enter the U.S. market while marijuana is only legal on a state-by-state basis. Curt Haag, vice president of casualty underwriting for AM Trust says casualty policies have an all-encompassing exclusion for cannabis. “With the conflict between state and federal laws, insurers don’t want to have anything to do with covering marijuana until that is settled.”

At the very least, carriers operating in this space must take the time to read the regulations of the states where they are considering operating. “Any time you get into a heavily regulated industry or operate in multiple states, carriers are taking a more conservative approach to covering those exposures,” adds Robert Pizarro, vice president of specialty lines for AM Trust. “Federal law will always take precedence.”

Some carriers are concerned about interstate commerce issues when it comes to insurance premiums. To circumvent these questions they use third parties to collect premiums because carriers can’t accept money from illegal entities. This allows carriers to comply with the spirit of the law, if not the letter.

McManamon says that carriers are operating within the confines of state laws, and the federal government doesn’t have the desire to go after these entities. “Everyone has to verify that they are operating within state law,” he adds.

Interestingly, while the federal government will not legalize marijuana, it is still willing to collect its share of taxes from cannabis-related companies. In some states, like Colorado, there are also state and local taxes of 15-20% in addition to federal taxes.

For plant-touching entities like Mary’s Medicinals, it’s possible for the company to pay anywhere from 65-85% in taxes on pre-tax revenues. This is due in large part to Section 280(e) of the IRS tax code, which does not allow businesses that qualify for the federal definition of “trafficking” of Schedule 1 or Schedule 2 substances to deduct what would otherwise be considered ordinary business expenses. Even though these state-compliant plant-touching operations are legal in their local jurisdictions, the government views them as illegal and says they meet the federal definition of “trafficking.”

Insurers and financial institutions doing business with cannabis-related entities must ensure they are operating as legal entities. “The biggest worry is that they (carriers) have to watch for money laundering, conspiracy or aiding and abetting in drug trafficking, etc.,” says Fox. “The rescission of the Cole memo [which provided guidance regarding marijuana enforcement under the Obama administration] has not ended up in a crackdown on businesses involved in or with the cannabis industry.”

This much is clear. There is a substantial amount of money involved in cannabis-related businesses, whether it is creating, operating, insuring or taxing them. The issues for carriers will be how to define the risks, assess the real costs, create the products, and do it all within the confines of the law.

Patricia L. Harman (pharman@alm.com) is editor in chief of Claims Magazine.

Sidebar

Glossary

Marijuana – A plant from the Cannabis sativa L. species. It is a psychoactive drug that can be smoked, consumed and incorporated into other products. It may cause depression, excitement, sleepiness, relaxation, short-term memory loss, dizziness and other reactions in individuals, and is frequently used for pain management. It cannot be prescribed by a physician, only recommended. Identified as a Schedule 1 drug by the U.S. Drug Enforcement Administration, these substances or drugs are considered to have no currently accepted medical use and have a high potential for abuse. Other drugs in this category include heroin and Ecstasy. Different parts of the plant, including the leaves, stems, flower buds and products extracted from it, can be smoked, eaten, vaporized or incorporated into a variety of products ranging from brownies to salves and lip balm.

Cannabis – Another name for marijuana, cannabis comes from Indian hemp plants. It has three primary forms: marijuana, hashish and hash oil.

Tetrahydrocannabinol (THC) – This is the active chemical in marijuana that can cause the psychological effects experienced by users. It can cause hallucinations, delusions and short-term memory issues. The effects may last several hours, but the presence of THC in the blood does not mean an individual is still impaired. Depending on how the marijuana is ingested, THC may affect an individual in 10-30 minutes or up to several hours later if taken through an edible such as a brownie or cookie. THC will show up in blood and urine tests several days to several weeks after ingestion.

Hemp – Also known as industrial hemp, this is grown for industry (commercial use) and has lower levels of THC. Its seeds can be crushed and added to oils, food and beauty products, and its fibers are used in rope, fabrics, paper and other products.

Cannabidiol (CBD) – Found in plants, it does not produce the high that THC does, but it is still used to help manage pain, reduce inflammation and lower anxiety. Reportedly, CBD can help reduce the psychoactive effects of THC depending on how much of each compound is consumed.

Dispensary – The retail entity that sells marijuana-related products to consumers. Many also offer other wellness-related services.