Why cannabis companies are seeing lower D&O rates

Pricing for cannabis-related directors and officers (D&O) insurance is trending downward, but only relative to the rest of the market, said an insurance brokerage executive.

“When cannabis was first legalized in Canada, you had a handful of carriers that [offered] coverage,” said Isaac Bock, managing director at AlphaRoot, a New York City brokerage focused exclusively on the cannabis, hemp and cannabidiol industries.

“A lot of those bore the brunt of all the claims activity early on. I think that led to some of the inflated premiums that a lot of these cannabis companies feel that they spend for coverage.”

The gap’s become smaller – with cannabis companies no longer paying as high an additional percentage – due to new underwriters coming online to create more supply for D&O.

“It’s still expensive, don’t get me wrong,” he added. “It’s simple laws of supply and demand.”

When cannabis companies merge, they often seek D&O insurance to protect their board members in the event something unforeseen happens during an acquisition. As a result, said Bock, cannabis insurance supply is down in part due to high M&A activity and initial public offerings (IPOs) in the space.

M&A is particularly strong in the U.S. “You see that a little bit in Canada, more so in some of the more mature markets in the U.S.,” he said. “Anytime you have M&A activity, you typically have some sort of suit that follows.”

IPOs are also partly contributing to insurers’ claims costs because “every IPO that occurs is such a learning experience for some of these companies,” he said.

And while the D&O capacity now coming online may not be what some operators would like, it’s promising compared to what was there a few years ago. “As we continue to see losses develop in this space and carriers come online,” Bock said, “we’ll see pricing probably trend downwards.”

After recreational marijuana was legalized in Canada in October 2018, many lawsuits were filed alleging mismanagement or financial misrepresentations by cannabis company board members. But as those board members gained experience in the business, claims against them have trended downward.

“You had a lot of leaders of these companies, C-suite executives, that came over from maybe the illicit market to run some cannabis companies [without] necessarily having any background in business,” Bock said. “Some of those mismanagement examples came from leadership not really having the experience of running companies.”

Investment bankers diving into an unknown market were forced to make projections “based on…maybe some other industries that they thought were similar,” Bock said. “But no real concrete financial examples from cannabis operations. I think you saw some lawsuits stem from that.”

Another potential D&O issue is cross-border operations. Some cannabis companies are listed on different stock exchanges, such as the Canadian Securities Exchange, New York Stock Exchange, or NASDAQ. The companies listed on those exchanges generally need to reach a certain market size; the higher your market cap, the more shareholders you’ll have.

“The more shareholders you have, the more people that have a financial interest in you as a company,” Bock said. “You open yourself up to some additional liability by virtue of bringing on additional shareholders.”

This article is excerpted from one that appeared in the February/March issue of Canadian Underwriter.

Feature image by iStock.com/Romolo Tavani