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HUB International 2021 Outlook

Cannabis Industry

 

Transforming Uncertainty into Opportunity

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Record Growth Despite Persistent Roadblocks

The cannabis industry continues to evolve despite government shutdowns, bad timing and the risks of research and outdoor cultivation.

A solid risk management program is needed to ensure future success.

The Canadian cannabis industry – worth an estimated $2.2 billion in annual retail sales – continues to grow at record pace, despite the COVID shutdown and the resulting delayed start of the newly launched edibles market.

“As cannabis companies search for equilibrium, many fall behind in instituting a proper risk management structure from R&D to daily operations.”

March 2020 actually saw an increase in sales, as Canadians purchased extra cannabis products while they were also stocking up on toilet paper and flour. Most cannabis operations were operating during the country-wide shutdown, but they were doing so with extra safety protocols for protecting employees and clients.

At the same time, consumers are maturing in their preferences, right along with the industry. They are less focused on THC percentages and more interested in terpene profiles, which impact the smell and taste of the product.

The industry has learned a lot over the last year, but there are pain points ahead. Market data shows producers are stockpiling more cannabis than ever. For example, data from Health Canada shows roughly 9 million packaged units available in April, compared with just 1 million in sales.

As cannabis companies search for equilibrium, many fall behind in instituting a proper risk management structure from R&D to daily operations. This includes appropriate coverage for outdoor cultivation, which is set to surpass indoor and greenhouse. Cannabis businesses that haven’t incorporated risk management will need to in 2021, especially when looking to secure private equity funding.

As the second fastest growing industry in Canada, maturing at more than 28% annually, cannabis sales are not likely to slow down. Experts predict continued growing pains – and gains – to shape the industry in 2021.

“Deemed 'essential businesses,' many retail outlets and dispensaries remained open throughout the pandemic and adopted new ways of serving customers, from curbside pick-up to drive-through windows and deliveries.”

1. COVID-19 will continue to advance cannabis industry growth — with a few roadblocks.

Deemed “essential businesses,” many retail outlets and dispensaries remained open throughout the pandemic and adopted new ways of serving customers, from curbside pick-up to drive-through windows and deliveries. At the same time, the pandemic hindered growth for some cannabis operations on the cusp of obtaining a license, as many applications were put on hold when government offices closed their doors for months. In some cases that meant raised capital was pulled and funding ceased. For start-ups that want to apply again in 2021, it’ll be an uphill climb.

During routine COVID-19 inspections in 2020, officials found a host of other issues at cannabis operations, including incorrect labelling, poor safety and health practices, lack of PPE compliance by staff and customers, incorrect counting of cash and more. In extreme cases, these visits resulted in regulatory fines and shutdowns. In 2021, there may be employment practices liability (EPL) claims that the employer didn’t adequately protect the employees – which may lead to lawsuits. These accusations dovetail with another major charge often levied against cannabis businesses — lightning speed growth without the business operations and risk management protocols necessary to support it.

Many cannabis businesses have not procured the necessary liability insurance coverage for the great risks that come with rapid growth. In many cases, there are also health hazard exclusions, which can limit liability coverage or even exclude losses altogether. Whether it’s D&O and EPL policies as in the case above, or Cyber, Environmental, Property or General Liability (GL) policies, it’s critical to think more holistically about insurance coverage. Cannabis operations must work with an insurance broker that specializes in the industry and understands different operations and business location, as exposures vary greatly.

Many cannabis businesses have not procured the necessary liability insurance coverage for the great risks that come with rapid growth.

“When it comes to new edibles products, the most significant exposure may be product labelling.”

2. Legalization of edibles is looking for a do-over.

Experts had high hopes in October 2019, when edibles were legalized. Since so many potential customers are put off by smoke and other health concerns, some were predicting that the edibles market would overtake the rest of the cannabis market. Then COVID hit, derailing the rollout of a wide variety of new products and start-up companies. As we approach 2021, hopes are high again that the derailment will turn into a simple delay

When it comes to new edibles products, the most significant exposure may be product labelling. The regulations from Health Canada outline the requirements for labelling cannabis products, including edibles, beverages and even topicals. Organizations that don’t follow those guidelines will find themselves with a major problem. This is an industry in its infancy, so change is a constant and staying on top of the regulations is challenging. An insurance broker familiar with the industry can help guide organizations to meet those labelling requirements and avoid the risks.

“R&D Extraction will be a major focus for cannabis organizations in 2021.”

3. R&D extraction dangers and breakthroughs lead to novel risks.

Cannabis extractors will continue to experiment with new ways to apply existing methods with butane, ethanol and CO2 as well as innovative methods adopted from the agriculture industry, using water and light exposure and different nutrients for extraction. Extraction R&D will be a major focus for cannabis organizations in 2021. Operations continue to search for a competitive advantage to increase yield and develop a superior product. This becomes a potential liability when cannabis extractors modify the use of existing equipment for a different type of extraction. Flammable products are often used, and explosions are common.

If you are considering experimenting with R&D, engage your insurance broker to ensure the risk is covered within your existing policies and to explore best practices for experimentation and varying equipment use.

 

“Canadian growers harvested more outdoor cannabis than ever before bringing some real perils whether it’s an early frost or a wildfire.”

4. Risks of outdoor cultivation lead to the growth of parametric insurance.

This year, Canadian growers harvested more outdoor cannabis than ever before. With so many new factors to consider – nutrients, pest control programs, wind mitigation, genetic programs – there was a big learning curve for those that chose to take the leap. But with all the factors an organization can control, there are many that they can’t. Whether it’s an early frost or a wildfire, outdoor cultivation brings with it some real perils. And as the weather becomes less predictable due to climate change, growers are ever more at risk.

The fact is, traditional crop insurance isn’t available for cannabis cultivators. Insurance generally is based on data, and there just isn’t enough data yet on cannabis crop yields for the traditional solutions to kick in. Meanwhile, the growers are assuming all the risk.

But there is one way to deal with the uncertainty. Parametric insurance is a program that pays out after a certain parameter is met. For cannabis crops, those parameters are weather-related, such as rain, wind and hail. If you are concerned about weather events negatively impacting your yields, work with your broker to develop a parametric insurance plan and identify the appropriate strike points.

“Organizations are taking steps to better control their product and their economic futures, but it’s also important that cannabis organizations carry appropriate coverage.”

5. An industry growing by leaps and bounds requires appropriate property protection.

As the cannabis industry matures, organizations are taking steps to better control their product and their economic futures. It’s also important that cannabis organizations are carrying appropriate coverage to protect their property. Property insurance covers vandalism and theft, as well as any weather-related threats that can destroy a cannabis facility.

Fires are especially common. For example, Canopy Growth had a fire at an unused greenhouse in early November. Several other grow ops have had fires related to faulty grow lights. If the lights break, hot glass shards can lead to fire. In each case, the plants are destroyed – along with your profit.

When looking for a new property insurance policy, or even preparing for a renewal, underwriters are cautious about taking on unnecessary risk. They will be looking to learn about your equipment. Doing your homework ahead of time can ease the renewal process and make it easier to get appropriate coverage.

For all cannabis businesses, 2021 will be about building on what they’re already doing and preparing for what will hopefully come next.

2021 Growth and Beyond

While the cannabis industry is changing, much will remain the same in 2021. Despite the supply and demand challenges, as well as the re-launch of the edibles market, cannabis growers and producers are doing the right things. For all cannabis businesses, 2021 will be about building on what they’re already doing and preparing for what will hopefully come next.

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