It’s no secret that the cannabis industry is high-risk, high-reward. It is rapidly growing, with new laws and regulatory frameworks being put into place as legalization expands across US states. Twenty nine states and a couple of US territories have legalized the medical use of marijuana and among those, eight states and Washington, DC also allow recreational use by adults.

What is the difference between medical marijuana and recreational marijuana?

The marijuana plant is made up of over 100 chemicals, known as cannabinoids; each of these having different effects on the body. Recreational marijuana usually has more THC content than the medicinal variety. THC (or tetrahydrocannabinol) is the chemical compound in cannabis providing users with a euphoric high.

However, marijuana – whether for medical or recreational purposes – is on the United States Schedule I list of banned substances, along with cocaine, heroin and methamphetamine. Because of this, no doctor can prescribe marijuana.

However, physicians can write an approval for recommendation for patients. It varies by state, but patients take this written documentation to a nearby dispensary and pick up their medication.

The Supreme Court has confirmed that the federal government has the right to regulate and criminalise the sale and use of cannabis, even when state law permits the use for medical purposes. But it does not stop there. Federal law also punishes anyone who “aids, abets, counsels, commands, induces, or procures” the commission of a federal crime by another. Those found guilty are punishable as a principle, just as if he or she had committed the offense. Therefore, these are not just problems for companies growing and selling marijuana, they are issues for anyone who transacts with the industry – e.g. armored car companies, marketing firms, and insurance agencies.

So, how do you operate a legitimate business in this environment? Imagine running your business without banking support. No banking access means paying employees, bills, and taxes in cash or money orders. It means no credit or debit card payments from clients; no small business loans or real estate mortgages.

There are many horror stories, including a company forced to run a 500-person payroll in cash; people carrying $40,000 in backpacks to grocery stores so they could buy money orders; accounts with non-cannabis related names; and bankers who advised customers to deposit less than $9,000 at a time to avoid getting too close to federal reporting requirements. There is cash being shipped in the back of cars, stuffed into safe-deposit boxes, locked away in hidden home safes and in some cases, buried in the ground. All of this creates scope for true criminal activity.

There was some guidance issued to banks in 2014, however just over 300 banks chose to serve the cannabis industry, which is less than 3% of the nation’s federally regulated bank and credit union population. Offering banking services to the
industry is a very onerous and risky decision but has the potential to be a great revenue source if done properly.

Firstly, banks must conduct extensive due diligence upon the cannabis-related business to determine its suitability and compliance with federal guidance and state law. This due diligence includes, amongst other things:

1. Verifying that the prospective cannabis-related business customer is licensed and registered with the appropriate state authorities;

2. Requesting and reviewing available information about the business and related parties from state-licensing and enforcement authorities;

3. Developing an understanding of what is normal and customary business activity;

4. Ongoing monitoring of publicly available information about the business and related parties; and,

5. Ongoing monitoring of suspicious activity, including “red flags” set out by FinCEN.

Secondly, the bank must file appropriate Suspicious Activity Reports (SARs) with FinCEN. As a predicate, a financial institution is required to file a SAR if, amongst other reasons, the financial institution knows, suspects or has reason to suspect that a transaction conducted through the financial institution involves funds derived from illegal activity. Because federal law prohibits the distribution and sale of marijuana, even funds derived from state-permitted businesses are considered funds derived from illegal activity.Therefore every transaction requires a SAR – a time-consuming effort for those involved. There are two types of SARs – “Marijuana Limited” and “Marijuana Priority” – both require different levels of information and documentation depending on whether due diligence uncovers any of the red flags.

Colorado’s attempt to create a state bank for the marijuana industry failed when the Federal Reserve refused to sign off on the plan. The state chose a credit union that would follow the stringent rules required of marijuana businesses, but the Federal Reserve said in a court filing that it would not act because the drug is illegal under federal law. The case was argued on appeal in November 2016 to the 10th U.S. Circuit Court of Appeals, and an opinion is pending. California has also made attempts to create a state-owned bank for the industry and run into multiple similar roadblocks. A Credit Union solution was also attempted, but also failed due to the inability to obtain Federal Deposit Insurance despite looking for the cover in both the traditional and captive markets.

To compound this problem, marijuana can’t be bought with a credit card as it is a Schedule I drug under federal law, and dispensaries can’t have their own corporate cards. This creates an even larger cash problem for the industry.

A recent survey by the Growers Association found that 75 percent of its members don’t have a bank account, and the ones who do have had three or more accounts closed in the course of doing business.

As you can see, most of the industry is not able to transact business in the traditional way and it means a lot of cash must be stored somewhere; this makes marijuana businesses an even greater target for crime. This sets up companies as a target for robberies and businesses must not only protect themselves but their employees in handling the large volumes of cash.

Just like big banks, insurance carriers have largely shunned the cannabis industry. In June 2015, Lloyds of London instructed its syndicates to cease underwriting and providing insurance to marijuana businesses. With nationwide annual sales to exceed $7 billion, insurance coverage should be plentiful and easily obtained – not exiting the market.

What is causing the insurance industry to alienate this industry?

  • Is insuring a federally illegal activity a criminal activity, rendering the insurance contract unenforceable? What will the courts say regarding insuring an illegal activity? This is a major risk for the business that purchases the policy.
  • Many traditional insurance policies exclude coverage for “illegal activities,” “criminal acts” and “intentional behavior.” Exposures such as civil RICO claims, money laundering and reputational risk are valid concerns for businesses involved in the cannabis industry. But can these exposures be covered by an insurance policy?
  • Can jurisdiction make a difference to the question – for example a non-USA jurisdiction offering a captive solution?

Currently, the industry purchases insurance through the non-admitted markets. There is less competition, more stringent underwriting and limited coverage offerings in these markets. Most businesses simply opt out of insuring all their risk as it is just too difficult to obtain coverage.

This is where captive insurance has presented an effective solution for businesses historically facing more exotic business risks for which coverage was not available or affordable on commercial markets, such as product liability or toxic tort exposure.

Note that the Internal Revenue Service prohibits marijuana companies from deducting their business (including insurance) expenses.

However, they will need a domicile for their captive and this poses yet another hurdle for the industry. The U.S. runs the issue of conflicting with the federal government and in reality is powerless to change the Supreme Court’s stance with the current administration in place. Even if it can find a domicile to approve the captive, it must also find a bank willing to hold the capital.

In addition, providing insurance to a cannabis business could arguably subject individuals, companies and potentially regulators to a criminal charge of aiding, abetting, or conspiring to violate the Controlled Substances Act.

So where does this leave an emerging industry that is estimated to grow by 700% by the year 2020?

The only real solution to the conflict, experts say, is for Congress to remove marijuana from the list of Schedule I narcotics, putting the drug on par with an FDA-regulated medicine rather than heroin. Until this is changed, this is an industry that unfortunately is going to be forced to operate in unconventional ways.

Contract Surety Underwriter at