Cannabis captives

Ahead of the game

Bermuda has long been the leading jurisdiction for captives and, in November 2019, the Island, ahead of other jurisdictions, clarified its position on cannabis and captives.

The Bermuda Monetary Authority (BMA) issued a notice, stating that Bermudian re/insurers could work with cannabis companies, provided the business didn’t constitute criminal conduct at the federal level in the jurisdiction in which the business is carried out.

It was excellent timing—the move marketed the Island to prospective cannabis companies shortly after cannabis became federally legal in Canada, explains Patrick Ferguson, a senior vice president with Marsh Captive Solutions.

“This first mover advantage allowed Bermuda to gain market share in this industry while other captive insurance domiciles continued to evaluate their position on recreational cannabis company captives,” he says.

Bermuda is seeing “significant signs of growth and interest in the captive model” primarily from cannabis companies headquartered in Canada, adds Kim Willey, senior counsel (consultant) at ASW Law.

According to Willey, numerous cannabis companies have set up or considered a Bermuda captive, either as a standalone licensed entity, or as part of a segregated account (“rent-a-captive”) structure.

She says: “To date, the use of such captive vehicles has primarily been for director and officer coverage, which is either not available in the commercial markets, or is economically not viable.

“However, we are seeing interest in cannabis companies using the captive for either traditional insurance lines or risks associated with cannabis (eg, product liability), and expect that we will see additional lines of business placed in captives as the industry matures and loss history is developed.”

With Bermuda having licensed several recreational cannabis captives in the past 12 months, there is greater clarity and understanding on how to structure risk within these captives to ensure compliance with the BMA’s directive, adds Ferguson.

“To date, the use of such captive vehicles has primarily been for director and officer coverage.”
Kim Willey, ASW Law

Stifled growth

While interest from Canada continues to grow, the expected growth of Bermuda as a captive insurance domicile for US marijuana entities has been stifled. The BMA’s notice effectively prohibits, in most instances, BMA-regulated entities from handling re/insurance for entities involved in the marijuana industry in the US due to its federal illegality, explains Neil Hitchcock, chief executive officer at Skyfront Bermuda.

“The primary obstacle to such growth is the BMA’s current position. Successful passage of legislative reform in the US, such as the Secure and Fair Enforcement Banking Act of 2019 or the Clarifying Law Around Insurance of Marijuana Act of 2021 would likely lead to a reversal of the BMA’s position and enable BMA-regulated firms to enter or re-enter the space,” he explains.

Combined, the two bills provide a legal safe harbour for insurers and financial companies to provide services to cannabis companies in states where the drug is legal.

Ferguson adds: “Certainly, the Bermuda position that all captive insurance risks must be federally legal could be an obstacle in the future for those Canadian or US cannabis companies with insurance risks that are only state-level legal in the US.”

He warns that there’s also a risk that some states in the US with captives legislation could start permitting captives for those companies with only state-level legal risks, potentially cutting into the market for Bermuda.

“Until there is more data for insurance companies to review, they will offer coverage only at higher rates/lower capacity.”
Patrick Ferguson, Marsh Captive Solutions

Reputational risk

Despite the US obstacle, market conditions and the lack of other alternative risk options mean that Bermuda is seeing growth for cannabis captives. The insurance market has traditionally been reluctant to work with cannabis companies, not least because of the legal uncertainty.

“Others are concerned over reputational risk although this has markedly reduced over the past couple of years as the global cannabis industry becomes more established,” says Hitchcock.

“The position of re/insurers and ancillary businesses such as brokers can also be affected and determined by the concerns of investors whether private or public.”

He adds that, in Bermuda, the main barrier is regulatory, regardless of whether a market wants to write the business from an underwriting standpoint.

“In the UK it is not a regulatory issue, but Lloyd’s as a market advised its syndicates to cease writing US-exposed marijuana business is 2015. Similar to Bermuda, there are Lloyd’s syndicates that would like to participate but are consequently unable to do so,” he says.

Coupled with legal uncertainty, reputational risk and regulatory barriers is the challenge of pricing risk, given the limited loss history of the industry, says Willey.

Insurers currently look to comparable industries (eg, the pharmaceutical industry) to model loss, she explains. “However, we expect that this will be less of an issue as the cannabis market matures. Even as the market matures, we expect that commercial insurance pricing will still be cost-prohibitive in the industry for certain insurance products, making a Bermuda captive a desirable cost-effective risk mitigation tool,” adds Willey.

Ferguson agrees, adding that the recreational cannabis industry is still viewed as new and, as such, some insurance companies are hesitant to work with cannabis companies.

“Until there is more data for insurance companies to review, they will offer coverage only at higher rates/lower capacity if indeed they are willing to offer coverage at all,” he adds.

Making the right choice

All this means that there are relatively few markets offering insurance for cannabis companies, which has kept pricing at an extremely high level, explains Hitchcock.

Agreeing, Ferguson notes that, for cannabis companies struggling to get coverage at affordable premiums or appropriate capacity from the insurance market, a captive is an excellent alternative risk vehicle.

He adds: “Some risks require insurance, and a captive vs other alternative risk options allows these cannabis companies to show that evidence of insurance.”

For cannabis companies, another benefit of forming a captive comes in the form of greater control. Hitchcock explains: “In the US, policy language from insurers can be prohibitive to the point where little cover exists for the exposures of the insured client. Having greater control over policy language would be of significant benefit.”

It’s not just control over policy wording that makes captives alluring—there are many opportunities to control and mitigate risk through the use of a captive. For example, says Willey, a Canadian company may require a director and officer insurance policy in order to attract and retain quality board members and management to grow their business.

“Market quotes for such coverage are either non-existent, or are at rates and coverage levels which are not justifiable from a business sense. The company could instead set up a Bermuda captive to write the policy, set the levels of coverage and then place capital and premiums into the captive which remain as funds of the company,” she adds.

Some of these funds, with BMA approval, can be lent back to the parent company or invested by the captive to earn a return. And, with the company paying its own losses, it will be motivated to prevent such a loss from ever occurring.

Willey continues: “This means further director and officer training, enhanced controls on decision making, and reduced risk exposure by the company. The overall result is a self-governed risk mitigation tool providing a necessary insurance product at rates lower than the commercial market.”

In view of the myriad benefits of captives, it’s clear that the formation of this alternative risk vehicle can offer cannabis companies a multitude of opportunities.

“With mergers and acquisitions activity set to continue apace over the next few years, cannabis companies will become larger, making the addition of a captive to their risk management strategy more economical and potentially beneficial,” Hitchcock concludes.

By forming on Bermuda, captives can take advantage of the knowledge and experience of the leading global captive insurance domicile, and make use of a clear and sophisticated regulatory regime. .

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Image Credit: / iQoncept, Yarygin