Risk Management Challenges for Cannabis Businesses

The legal cannabis market is growing rapidly. It was valued at $9.1 billion in 2020, and industry experts anticipate the cannabis industry will be worth $146 billion by 2025, making it one of the fastest-growing industries in the United States.

As demand grows for both medical and recreational marijuana, manufacturers, distributors, retailers and other industry players are exposed to evolving risks related to regulation and product usage. Review the following article to understand some of the risks cannabis businesses face and get a glimpse into the losses they are experiencing.

Given the rapid changes that have taken place in the cannabis industry, many cannabis-related losses are still in litigation or have yet to be collected. While Advisen data contains more than 400 of these losses, the database focuses primarily on large and significant losses.

Here are the most frequent types of losses at cannabis-related businesses (CRBs), according to Advisen data:

Cannabis losses by line of business

Directors and officers (D&O) is the most frequent line of business to have cannabis-related losses at 36%, followed by cyber at 19%.

D&O losses at CRBs

CRBs are particularly vulnerable to D&O lawsuits due to a lack of established standards regarding cannabis products and regulatory uncertainty over the legality of cannabis. These uncertainties may cause a CRB’s stock value to decline (if the business is a public company), resulting in shareholder lawsuits alleging directors and officers failed to properly navigate regulatory obstacles or made misleading statements about a product’s clinical trial results.

D&O losses at CRBs by type

Securities class action is one of the most common types of D&O losses at CRBs. Capital regulatory action and derivative shareholder action are also common loss causes.

Cyber losses at CRBs

Unauthorized contact or disclosure accounts for the majority of CRBs’ cyber losses at 69%. Such infractions include any event in which information is shared with unauthorized parties. Malicious data breaches account for 15% of cyber losses and unintentional disclosure accounts for 10%.

Information targeted at CRBs

When a cyber loss occurs at a CRB, data shows personal identifiable information (e.g., name, address, Social Security number, etc.) is the most frequently targeted. Personal health information and personal financial information were targeted less frequently.

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Regulatory risks

Some form of medical or recreational cannabis is legal in most states, but at the federal level, cannabis remains a Schedule 1 drug, which is illegal to produce and distribute. The inconsistencies between state and federal laws often create problems for CRBs because of the following reasons:

  • Lack of insurance options—Many traditional standard market insurers have avoided writing policies for CRBs due to the fact that cannabis remains illegal at the federal level. As a result, CRBs have often had to obtain coverage in the excess and surplus marketplace at a high cost and with less comprehensive policy terms and conditions. For some, the inability to procure proper and affordable insurance has made starting and operating a new cannabis business too risky or expensive.
  • Banking restrictions—Cannabis businesses operating with state legality also often face difficulties accessing traditional banking and financial services due to the illegality of cannabis at the federal level. According to the National Association of Insurance Commissioners, 70% of CRBs operate as cash-only businesses and have no formal relationship with a bank, increasing the risk of theft and other liabilities.

The exposures CRBs face are aggregated by the industry’s newness, the nature of cannabis products, and the discrepancy between state and federal laws. For more information on the state of the cannabis market, contact Rama today at [email protected] or 248-595-0728.

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