(Editor’s note: This story is part of a recurring series of commentaries from professionals connected to the cannabis industry. David Kennedy is the founder and CEO of New York-based Purple Risk Insurance Services, a provider of insurance and risk-management services to the marijuana and hemp industries.)
Cannabis industry authorities predict more bankruptcy filings and insolvency proceedings by cannabis companies in 2020.
Under this scenario, businesses low on cash struggle to raise funds or are unable to compete, forcing them to seek protection under federal bankruptcy and/or state insolvency and receivership laws.
In a constantly evolving and tumultuous market, owners, board members and executive officers of both private and public cannabis companies should consider – and many are required to obtain – directors and officers liability insurance (D&O) to protect against an increasing number of financial risks.
Directors and officers of cannabis businesses that made poor investments or acquisitions, for example, are facing scrutiny from the U.S. Securities and Exchange Commission and lawsuits from investors.
Risks from various sources
Cannabis companies face potential exposure to claims by investors, customers, vendors, competitors and others for mismanagement, misrepresentation, breach of duty, misappropriation of trade secrets and unfair competition – to name a few.
These risks exist whether a company is private or public.
D&O liability insurance protects directors and officers from claims made against them while serving on a board or as an officer of a company.
D&O policies function as “management errors and omissions liability insurance” covering claims resulting from managerial decisions that have adverse financial consequences.
Simply put, without D&O liability insurance, directors and officers expose their personal finances in the event of a lawsuit.
D&O policies protect the personal assets of directors and officers – and, typically, the company – when they are sued for alleged mismanagement of the company.
A D&O policy covers legal fees, settlements, damages and other costs.
In 2019, after several years of declining or flat insurance premium renewals, traditional industries in the U.S. were facing growing double-digit rate increases in a hardening D&O liability insurance market, Business Insurance reported.
Global insurance broker Aon recently calculated that the premium for $1 million in D&O coverage increased substantially each quarter last year, up 13.8% in the first quarter to 29% in the third quarter of 2019 versus the same period the previous year, according to Business Insurance.
This trend of double-digit D&O premium hikes is continuing to surge into 2020 and “is expected to continue at least through this year,” especially for public companies, the publication noted.
Depending on several factors – including the type and size of company, revenues and prior claims – pricing for traditional industries is in the upper range of $10,000 premium per $1 million D&O coverage limit.
Unique marijuana industry insurance risks
In the cannabis space, only four insurers are willing to provide D&O for plant-touching companies with a THC exposure, according to insurance industry sources I interviewed.
D&O rates in the cannabis industry are anywhere from two to 10 times higher – from $20,000 to $100,000 minimum premium per $1 million limit – according to cannabis insurance experts.
D&O liability insurance, including broader coverage for both federal and state regulatory actions, falls in the high end of the premium range.
About a dozen insurers provide D&O coverage for hemp and CBD-related companies, but the minimum premium begins at $20,000, according to the cannabis insurance industry sources I contacted.
By comparison, about 500 insurers provide cyber liability insurance with 140 individual insurers offering stand-alone cyber insurance policies, according to Insurance Business America. Multiple insurers also offer D&O coverage to traditional industries.
CannGen Insurance Services, a managing general underwriter in the cannabis space based in California, agrees with the staggering 10 times surcharge for cannabis industry D&O premiums:
“In the last several months, we have seen D&O pricing at no less than $100,000 premium for a $1 million limit” and “multiples of that in some cases,” Richard McGee, director of financial lines at Next Wave Insurance Canada, a sister company of CannGen and a subsidiary of Next Wave Insurance Services, told me.
“Almost all funding and lending institutions now demand cannabis-related businesses carry D&O liability insurance as a contractual requirement” and “directors and officers don’t want to expose their personal finances,” putting increased pressure on cannabis companies to purchase D&O, he added.
D&O liability insurance premiums for publicly traded companies are even more expensive because of the potential exposure to securities class action lawsuits.
Massachusetts-based Tilt Holdings Chief Operating Officer Tim Conder told Insurance Journal at Marijuana Business Daily’s December 2019 MJBizCon that “the baseline measure for cannabis D&O is $200,000 in premium for every $1 million in primary coverage, (and) most companies require (a) minimum $5 million in coverage and $10 million is probably the average coverage amount.”
Tilt Holdings is traded on the Canadian Securities Exchange as TILT.
With only a few insurers willing to offer D&O liability insurance to the cannabis industry, the limited carrier options and exponential pricing might not improve in the short term.
But the demand and need for D&O protection continues to surge as the industry evolves and matures.
David Kennedy can be reached at david@purplerisk.com. Kennedy will serve as a moderator for a broker panel during the National Cannabis Risk Management Association’s conference, March 22-24, in Las Vegas.
The previous installment of this series is available here.
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