New legal and regulatory developments related to cannabis and the federal terrorism backstop are creating potential opportunities for captive insurers.
- Lori Chordas
- August 2018
By the Numbers: The number of captive insurance companies has more than doubled since 2001.
Risk and Reward: Companies are eyeing captives solutions for newer risks such as cyberterrorism and cannabis.
Now Is the Time: The limited availability of coverage in the commercial market for those risks is creating an opportunity for captives.
As the cannabis industry gains legitimacy at the state level, it is experiencing challenges in its efforts to line up adequate insurance coverage. That is creating the potential for opportunities for captive insurers.
In a separate sector, clarification that stand-alone cyber liability policies are included under the Terrorism Risk Insurance Act means captives now have more incentive to write cyberterrorism.
Camille Dixon, California Department of Insurance
I would say the biggest need right now is outdoor crop insurance.
The Cannabis Question
Recreational marijuana sales became legal in California on Jan. 1, 2018. While still illegal at the federal level, developments such as these are beginning to turn the cannabis industry into a legitimate business.
That is spurring demand for insurance coverages, which are still typically not offered by the traditional insurance market.
With coverage in the traditional insurance market so limited, businesses have had to explore the surplus lines market for coverage. It also has raised questions about the possible use of captive insurers.
“Along with supplementing or replacing commercial insurance, captives can, at the very least, be an effective tool in the risk management toolbox for cannabis entities seeking alternative ways to finance the emerging risks they face,” said Greg Fanoe, a consulting actuary at actuarial consulting services firm Merlinos & Associates.
California was the first in the nation to legalize marijuana for medical use in 1996. Currently, 30 states have legalized use of medical marijuana. Nine states and the District of Columbia have legalized the recreational use of cannabis.
In 2017, legal marijuana sales in North America climbed 33% to $9.7 billion and they're expected to top $47 billion over the next decade, according to cannabis research firm ArcView.
Californians in November passed Proposition 64, which allowed for the sale and taxation of recreational marijuana, effective Jan. 1, 2018.
Because the drug is still illegal at the federal level, however, many insurance brokers and banks have shied away from the industry.
Businesses and insurance industry representatives testified about the limited availability of cannabis business insurance at a public hearing in October held by California Insurance Commissioner Dave Jones, according to a BestWire report.
The California Department of Insurance said some insurance for the cannabis industry had only been available via surplus lines carriers. Golden Bear Insurance Co. became California's first admitted commercial cannabis insurer in early November after Jones approved the company's filing.
Some of the coverages the cannabis industry needs include coverage for crops, product liability and stock throughput, according to Camille Dixon, director of cannabis insurance policy for the California Department of Insurance, speaking at the Captive Insurance Companies Association's International Conference in Scottsdale, Arizona in March.
“I would say the biggest need right now is outdoor crop insurance,” she said.
Businesses involved with the cannabis industry include growers, distributors, retail dispensaries and others. Other coverages they could need include general liability, professional liability, commercial auto, workers' compensation and property.
Businesses looking to obtain and maintain a license in Washington state, for instance, are required to have product liability and commercial general liability coverages with minimum limits of $1 million, according to reports.
“Also, we've seen some carriers point to exclusions in policies or raise other arguments to deny coverage based on the fact that the policyholder was involved in cannabis operations, even when the carrier in at least one case knew its insured was a cannabis business when it issued the policy,” said Joseph Holahan, of counsel at Morris, Manning and Martin LLP in Washington, D.C.
When coverage is hard to find in the traditional market, captives can be one of the possible alternatives.
With good management and underwriting, captives have the opportunity to serve unmet needs in this market, said Holahan, whose experience includes assisting insurers with company formation and licensing, including the formation of captive insurers.
Joseph Holahan, Morris, Manning and Martin LLP
While the risk of prosecution may be low, a captive that accepts premiums from cannabis businesses is likely violating federal law.
“We're seeing more and more interest in forming captives to supplement commercial carriers' policies and cover risks that might not otherwise be covered or only covered at a high cost,” he said.
State regulators are beginning to entertain proposals to form captives that would write cannabis risks, Holahan said.
Captive insurers can offer better pricing and broader coverage than the traditional market.
“And captives have more flexibility than traditional and excess and surplus lines insurers to design programs, and they don't have to file rates or forms,” Merlinos & Associates' Fanoe said.
“One of the biggest complaints we hear in this market is that available coverage comes with many exclusions, especially liability policies,” he said.
That said, there are some significant hurdles, given that cannabis is still illegal under federal law.
“It can be difficult to find a good domicile for your captive, along with fronting carriers and legal partners to work with your captive,” Fanoe said.
While the risk of prosecution may be low, a captive that accepts premiums from cannabis businesses is likely violating federal law, Holahan said.
California's Dixon said the state is encouraging insurers to provide coverage.
“A lot of the insurance being written now is on the surplus side,” she said, speaking at the CICA conference. “We do have two admitted carriers. We have the first admitted carrier in the nation in California last year. We hope to continue to approve more carriers to write on the admitted side. The surplus market right now is definitely filling the gaps.”
A bipartisan bill that would give states autonomy over their marijuana policy could help to resolve some of the current challenges facing the cannabis industry. The Strengthening the Tenth Amendment Through Entrusting States (STATES) Act, cosponsored by Sen. Elizabeth Warren and Sen. Cory Gardner, would protect businesses in states with legalized marijuana from federal government interference and prosecution from the Department of Justice, according to published reports.
Cyberterrorism and Captives
In late 2016, the U.S. Treasury Department issued guidance that clarifies that stand-alone cyber liability insurance policies are included under the Terrorism Risk Insurance Act.
“That guidance now clarifies the scope of coverage for cyberattacks under TRIA and makes it very clear that captives can be used to write property and casualty-related cyberrisks,” said Wendy Peters, executive vice president and global head of terrorism and financial solutions at Willis Towers Watson.
Currently, the federal reinsurance quota share stands at 82%, leaving insurers to either retain the remaining 18% quota share or reinsure it, Peters said.
Michael Serricchio, managing director, Marsh Captive Solutions, agreed.
“That opens up a huge opportunity for all industries with their captives to insure cyberterrorism,” said Serricchio, speaking at the Captive Insurance Companies Association's International Conference in March.
“If it was certified as a cyberterrorist attack, the captive would have this year 82% backstop versus being self-insured for that loss if they didn't have it in their captive,” he said.
Last year the number of Marsh-managed captives writing terrorism coverage backed by the Terrorism Risk Insurance Program Reauthorization Act of 2015 climbed 17% to 166 captives, Serricchio said.
TRIPRA, which was signed into law by former-President Barack Obama on Jan. 12, 2015, extends the federal backstop program through 2020.
Wendy Peters, Willis Towers Watson
That guidance now clarifies the scope of coverage for cyberattacks under TRIA and makes it very clear that captives can be used to write property and casualty-related cyberrisks.
Terrorism acts must meet certain criteria to be designated under TRIA language. The U.S. government will provide reinsurance for losses that exceed the program trigger.
This year, captives are fully responsible for terrorism losses below $160 million. The trigger is set to increase $20 million annually until 2020, when it will reach $200 million.
There are numerous reasons why captives may be a viable means to insure against cyberterrorism.
Not only do captives reduce a company's reliance on third parties, they're also a cost-effective and relatively easy way to reduce and finance net retained risk, especially for companies that already own a captive, Serricchio said.
Additionally, the flexibility of captives helps them respond faster than traditional insurers in accommodating market dynamics and new risks such as cyber and other emerging risks.
“We're now seeing more captives taking meaningful retentions and building a tower of insurance excess of their retention,” said Anup Seth, managing director with Aon.
He said the advantages of doing that include the ability to control the overall insurance program including price, coverage and capacity to optimize the total cost of risk associated with cyber exposures.
There are some situations when a captive solution may be the only viable option, such as to secure significant limits for nuclear, biological, chemical or radiological attacks.
Although TRIPRA guidance states that the federal backstop provides reinsurance protection to insurers that experience NBCR losses, insurers are not required to offer the coverage, according to Marsh's 2018 Terrorism Risk Insurance Report.
That makes the concept of a captive writing the risk all the more beneficial, Serricchio said.
“The lack of a TRIPRA mandate for NBCR has resulted in coverage not being widely available in the traditional insurance marketplace. Captive insurers are able to offer this coverage and gain access to reinsurance protection afforded by TRIPRA,” according to the Marsh report.
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