Insuring the product liability risks of cannabis

The regulation of adult-use cannabis in California should focus on minimizing harm to the public and ensuring access to compensation for persons who may be harmed. Liability insurance can be one very useful tool for managing risks related to cannabis, although many typical liability insurance policies will be ineffective for this purpose. Cannabis businesses must be careful to ensure that they are properly insured for the substantial risks they face.

The cannabis industry has demonstrated remarkable efforts to comply with regulations and industry standards, but adult-use cannabis nevertheless is associated with a number of risks. In particular, the production, distribution and sale of an ingestible product that has psychoactive effects -- accompanied by a wide range of anticipated labeling and marketing requirements -- will certainly result in robust product liability litigation.

California's cannabis regulations require every licensee to have liability insurance, and public policy supports this requirement for several reasons. There is a strong public policy in favor of compensating those who suffer compensable injury. In addition, private insurance regimes often provide excellent loss prevention services directly -- and indirectly by their underwriting practices. Finally, liability insurance provides stability to industry participants.

What Product-Related Risks Face the Cannabis Industry?

Product liability laws hold product manufacturers liable for injuries caused by placing an unreasonably dangerous product on the market. Because cannabis remains illegal for any purpose under federal law, there are few long-term studies on the safety and efficacy of cannabis use. Certain risks associated with adult-use cannabis should nevertheless be anticipated.

One obvious hazard that will form the basis of product liability lawsuits arises from cannabis-infused edible products, which will soon account for the majority of the cannabis market. Consumers often do not realize that cannabis may take significantly longer to have an intoxicating effect on them when it is eaten, leading them to consume too much. The standard dose is currently 10mg THC (tetrahydrocannabinol, the principal psychoactive constituent of cannabis), which may be contained in one small portion of a candy bar sold to consumers. The industry is reacting to this problem by adopting strict dosage limits in understandable packaging, and by embracing the idea of "microdosing" edible products in portions as small as 1mg THC.

Other anticipated product liability risks arise from the widespread use of lithium-ion vaporizers, pesticides, contamination by mold and fungus, breach of warranty claims, misrepresentation, label claims and other failure-to-warn theories, consumer complaints that allege deceptive practices and bodily injury claims resulting from intoxication.

At this time, there is little judicial precedent for holding cannabis businesses liable for product liability as only a small number of cannabis-related product liability lawsuits have been brought. The number of new cases that have been filed at the trial court level is uncertain because of difficulty in gaining keyword search capability for documents filed with most county courts.

The Analogy to the Supplement Industry

The cannabis industry today is in a position very similar to the dietary supplement industry in 1994 when new federal legislation was enacted. The supplement industry was not required to receive FDA approval before marketing most new products. Numerous lawsuits over the next decade tended to clean up the industry, but at the cost of bankrupting a number of businesses. We already see signs of similar growing pains for cannabis. For example, the state of Colorado mandated 66 cannabis-related product recalls from Sept. 8, 2015, through April 26, 2017. California will present a much larger market, and we can expect the number of product defects to be much larger as well.

Unlike the supplement market, however, the cannabis industry has made enormous progress in self-regulation. We are encouraged by the risk management protocols that the cannabis industry is adopting, including a thorough licensure process, rigorous product testing, advanced "track and trace" programs, and the creation of standards by third-party organizations such as the ASTM International, a global standards development organization. Nevertheless, cannabis businesses will continue to be confronted by substantial product liability exposure and associated risks as the market matures.

Traditional Liability Insurance Policies Are Inadequate

Standard commercial general liability (CGL) insurance coverage is inadequate to protect a cannabis business from associated product liability risks. Standard CGL policies contain exclusions for injuries arising out of the use of a Schedule 1 drug, banned substances or other substances that constitute a "health hazard." Additionally, very broad pollution exclusions may hinder coverage of cannabis risks. Finally, these policies typically do not cover injuries resulting from the insured's "completed operations," meaning that once it sells the product it is no longer covered for harms caused by the product when later ingested. As a result, a standard CGL policy would result in illusory coverage for many risks facing licensees.

To date, California's licensing authorities have not mandated that licensees only purchase insurance products that clearly provide coverage for cannabis-related risks and include Product Completed Operations coverage. Although requiring businesses to have liability insurance makes perfect sense, it does not make sense if the coverage is inadequate.

Effective Insurance Coverage

Even if an insurance policy expressly provides suitable coverage for cannabis-related risks, the coverage will not be enforced by the courts if it is deemed to be in violation of public policy. In October 2017, Gov. Jerry Brown signed into law Assembly Bill 1159, which provides that any commercial marijuana activity conducted in compliance with California law and any applicable local standards, requirements and regulations shall be deemed to be all of the following: (1) a lawful object of a contract; (2) not contrary to an express provision of law, any policy of express law or good morals; and (3) not against public policy. Because cannabis is subject to severe federal criminal penalties, it is possible that a federal court might hold that a policy providing coverage for cannabis is unenforceable for reasons of public policy. See Tracy v. USAA Ins. Co., 2012 WL 928186 (D. HI. 2012), appeal dismissed (9th Cir. 12-16015, June 14, 2012).

We believe that the legislature must strengthen the declaration of California's public policy regarding cannabis. Public policy analysis involves a balancing of interests, and so it is important for California to declare that there is a very strong public policy in favor of insuring the cannabis industry, rooted in the important state interest in having compensation made available to injured parties. When balanced against under-enforced federal policies, a strong positive state policy is more likely to be respected. See Green Earth Wellness Center, LLC v. Atain Specialty Ins. Co., 163 F. Supp. 3d 821 (D. Colo. 2016).

As the adult-use cannabis market matures, we expect that insurers will provide effective insurance for the risks facing the industry. We encourage the state to ensure that businesses are operating with appropriate insurance in place. With the strong backing of California's insurance commissioner, Dave Jones, insurers admitted to the state have begun to underwrite cannabis businesses, and so businesses do not have to rely only on the surplus lines market. This transition should be managed carefully to ensure that the policies purchased are appropriate for the industry. Stay tuned.