Surety

The Buzz Over Bonds

Bonding requirements in the weed business are wildly inconsistent and sometimes seem biased against the industry.
By: | May 2, 2017 • 6 min read

Now that medical and/or recreational use of marijuana is legal in nearly a quarter of U.S. states, several are now requiring marijuana dispensaries and growers to obtain surety bonds to make sure the businesses are viable and upstanding.

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But some are questioning the high bond amounts required by states like Arkansas, Florida and Connecticut, claiming it’s “cannabigotry” in a drive to stamp out the controversial businesses. Colorado last year relaxed its surety bond requirements after too many mom and pop firms went out of business due to the tightening of the surety bond market there.

Some marijuana bonds guarantee compliance with a state license, but most often the bonds guarantee payment of tax revenue on the sale of marijuana, said Victor J. Lance, president and owner of Lance Surety Bond Associates Inc. in Doylestown, Pa.

“These bonds are currently very difficult to place, and most bond companies avoid writing them for primarily two reasons — federal law still makes possession and use of marijuana illegal, and the threat of RICO [Racketeer Influenced and Corrupt Organization] lawsuits,” Lance said.

In 2015, an anti-marijuana group sued several Colorado dispensaries and companies doing business with them, including Merchants Bonding Co., claiming they violated the federal RICO act. The surety bond firm settled and immediately exited the marijuana bonding business, and most other bond companies followed suit.

“However, there are still some bond companies willing to write these bonds for qualified applicants,” Lance said. “If federal law changes, which some think is only a matter of time, this will most certainly change as more and more bond companies re-enter the industry.”

Different Approaches

Regardless of federal law, state regulators “need to be thoughtful” in setting appropriate penal sums and determining bond language, he said. Some states like Florida and Connecticut require surety bonds for $1 million or more, but it’s very difficult, if not impossible, for most new businesses to qualify for a bond of that size.

Victor J. Lance, president and owner, Lance Surety Bond Associates Inc.

“If a state decides to require a bond that no bond company is comfortable writing, the requirement becomes unattainable for most businesses and can be detrimental to the growth of the marijuana industry in their state,” Lance said. “It’s important for state regulators to consult with the surety industry, such as the legal counsel at the Surety & Fidelity Association of America, before deciding on new bonding requirements.”

Colorado last year removed the surety bond requirements for marijuana firms. Other RICO lawsuits against marijuana firms and those that do business with them have since been dismissed by federal judges or turned down by the U.S. Supreme Court.

The Arkansas Medical Marijuana Commission proposed surety bond requirements for marijuana businesses wishing to obtain licenses, which must be approved by the Arkansas Legislature. The state will initially award 32 dispensary licenses on a lottery basis and five cultivation facility licenses based on the firms’ merits.

To qualify for a cultivation license, applicants must provide proof of assets or a surety bond in the amount of $1 million, an initial $500,000 performance bond, and proof of at least $500,000 in liquid assets.

For dispensary licenses, applicants electing to cultivate medical marijuana on the premises must provide proof of assets or a surety bond in the amount of $200,000 and proof of at least $100,000 in liquid assets.

Keith Mansur, publisher of the Oregon Cannabis Connection’s OCC Newspaper in Grants Pass, Ore., said that the Arkansas bond requirements for dispensaries are not overly odious, but the requirements for growers are.

“I think what’s really driving this is ‘cannabigotry,’ ” Mansur said. “They are afraid of the unknown and the Feds perpetrate the myth that cannabis is bad because they still classify is as a Schedule I controlled substance. But all of that ridiculous scheduling causes fear.”

Still, he’s not sure that having no bond requirement is a good thing.

Companies need to know “that there’s more risk involved than just opening their doors,” said Mansur.

Keith Mansur, publisher, Oregon Cannabis Connection newspaper

For smaller firms, a $10,000 license and/or tax bond runs between $300 and $1,500, said Gary Eastman, president of Swiftbonds in Leawood, Kan.

To get any type of surety bond, companies need to show three years’ worth of financials or the applicant needs to have great credit, Eastman said. For small firms, Swiftbonds typically asks for a basic profit and loss statement, but also encourages a balance sheet statement. As most dispensaries do not have a lot of assets, the firm looks for strong cash flow and sometimes a letter of credit or some other type of collateral.

“We tell companies that even if they can’t get a bond today, continue to work with the surety company, sending updates and financial statements,” he said. “If the company shows continuous progress and that they’re taking all the right steps — instead of trying to grow too aggressively, cutting costs so they can’t service customers — then they can ultimately get a bond.”

Some states, like Washington, don’t require surety bonds, but they do require dispensaries and growers to have commercial general liability insurance or commercial umbrella insurance, with limits of not less than a million dollars, said Susan Coakley, insurance specialist at New Growth Insurance in Alameda, Calif.

“Marijuana firms typically are cash-only businesses, so if they ever had an insurance claim, the insurer could not pay them $5,000 in cash to resolve the claim,” Coakley said. They’d need to use lawyers as intermediaries.

There are some brokers who are selling GL policies to marijuana firms so they can meet the regulatory requirements, but if the firms ever had a claim they wouldn’t be covered, she said. The red flag to watch for is verbiage in the policy that excludes the cannabis business.

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T.J. Frost, commercial and surety insurance adviser at HUB International in Seattle, said that in Washington, local utilities sometimes require marijuana firms to put money upfront, just in case they ever miss a utility payment. That amount could be in the range of $150,000, or around $8,000 for a startup. The fee for such a bond is 20 percent.

HUB’s risk services team also inspects properties and helps clients seeking insurance prepare by discussing potential fire hazards, sprinkler systems, light wire exposure, exit requirements and the need for cameras, safes and vaults.

“One thing we pride ourselves [on] is that we can help companies with risk mitigation, because there were companies that started out in people’s houses that were catching fire because they were doing it indoors,” Frost said.

HUB also brings in attorneys knowledgeable about the marijuana industry to work with clients on accounting, taxes and other issues.

“We want our clients to be successful; we want them to pave the way for others,” Frost said. “We try to be an advocate for them, not just their insurance broker.” &

Katie Kuehner-Hebert is a freelance writer based in California. She has more than two decades of journalism experience and expertise in financial writing. She can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Alternative Energy

A Shift in the Wind

As warranties run out on wind turbines, underwriters gain insight into their long-term costs.
By: | September 12, 2017 • 6 min read

Wind energy is all grown up. It is no longer an alternative, but in some wholesale markets has set the incremental cost of generation.

As the industry has grown, turbine towers have as well. And as the older ones roll out of their warranty periods, there are more claims.

This is a bit of a pinch in a soft market, but it gives underwriters new insight into performance over time — insight not available while manufacturers were repairing or replacing components.

Charles Long, area SVP, renewable energy, Arthur J. Gallagher

“There is a lot of capacity in the wind market,” said Charles Long, area senior vice president for renewable energy at broker Arthur J. Gallagher.

“The segment is still very soft. What we are not seeing is any major change in forms from the major underwriters. They still have 280-page forms. The specialty underwriters have a 48-page form. The larger carriers need to get away from a standard form with multiple endorsements and move to a form designed for wind, or solar, or storage. It is starting to become apparent to the clients that the firms have not kept up with construction or operations,” at renewable energy facilities, he said.

Third-party liability also remains competitive, Long noted.

“The traditional markets are doing liability very well. There are opportunities for us to market to multiple carriers. There is a lot of generation out there, but the bulk of the writing is by a handful of insurers.”

Broadly the market is “still softish,” said Jatin Sharma, head of business development for specialty underwriter G-Cube.

“There has been an increase in some distressed areas, but there has also been some regional firming. Our focus is very much on the technical underwriting. We are also emphasizing standardization, clean contracts. That extends to business interruption, marine transit, and other covers.”

The Blade Problem

“Gear-box maintenance has been a significant issue for a long time, and now with bigger and bigger blades, leading-edge erosion has become a big topic,” said Sharma. “Others include cracking and lightning and even catastrophic blade loss.”

Long, at Gallagher, noted that operationally, gear boxes have been getting significantly better. “Now it is blades that have become a concern,” he said. “Problems include cracking, fraying, splitting.

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“In response, operators are using more sophisticated inspection techniques, including flying drones. Those reduce the amount of climbing necessary, reducing risk to personnel as well.”

Underwriters certainly like that, and it is a huge cost saver to the owners, however, “we are not yet seeing that credited in the underwriting,” said Long.

He added that insurance is playing an important role in the development of renewable energy beyond the traditional property, casualty, and liability coverages.

“Most projects operate at lower capacity than anticipated. But they can purchase coverage for when the wind won’t blow or the sun won’t shine. Weather risk coverage can be done in multiple ways, or there can be an actual put, up to a fixed portion of capacity, plus or minus 20 percent, like a collar; a straight over/under.”

As useful as those financial instruments are, the first priority is to get power into the grid. And for that, Long anticipates “aggressive forward moves around storage. Spikes into the system are not good. Grid storage is not just a way of providing power when the wind is not blowing; it also acts as a shock absorber for times when the wind blows too hard. There are ebbs and flows in wind and solar so we really need that surge capacity.”

Long noted that there are some companies that are storage only.

“That is really what the utilities are seeking. The storage company becomes, in effect, just another generator. It has its own [power purchase agreement] and its own interconnect.”

“Most projects operate at lower capacity than anticipated. But they can purchase coverage for when the wind won’t blow or the sun won’t shine.”  —Charles Long, area senior vice president for renewable energy, Arthur J. Gallagher

Another trend is co-location, with wind and solar, as well as grid-storage or auxiliary generation, on the same site.

“Investors like it because it boosts internal rates of return on the equity side,” said Sharma. “But while it increases revenue, it also increases exposure. … You may have a $400 million wind farm, plus a $150 million solar array on the same substation.”

In the beginning, wind turbines did not generate much power, explained Rob Battenfield, senior vice president and head of downstream at JLT Specialty USA.

“As turbines developed, they got higher and higher, with bigger blades. They became more economically viable. There are still subsidies, and at present those subsidies drive the investment decisions.”

For example, some non-tax paying utilities are not eligible for the tax credits, so they don’t invest in new wind power. But once smaller companies or private investors have made use of the credits, the big utilities are likely to provide a ready secondary market for the builders to recoup their capital.

That structure also affects insurance. More PPAs mandate grid storage for intermittent generators such as wind and solar. State of the art for such storage is lithium-ion batteries, which have been prone to fires if damaged or if they malfunction.

“Grid storage is getting larger,” said Battenfield. “If you have variable generation you need to balance that. Most underwriters insure generation and storage together. Project leaders may need to have that because of non-recourse debt financing. On the other side, insurers may be syndicating the battery risk, but to the insured it is all together.”

“Grid storage is getting larger. If you have variable generation you need to balance that.” — Rob Battenfield, senior vice president, head of downstream, JLT Specialty USA

There has also been a mechanical and maintenance evolution along the way. “The early-generation short turbines were throwing gears all the time,” said Battenfield.

But now, he said, with fewer manufacturers in play, “the blades, gears, nacelles, and generators are much more mechanically sound and much more standardized. Carriers are more willing to write that risk.”

There is also more operational and maintenance data now as warranties roll off. Battenfield suggested that the door started to open on that data three or four years ago, but it won’t stay open forever.

“When the equipment was under warranty, it would just be repaired or replaced by the manufacturer,” he said.

“Now there’s more equipment out of warranty, there are more claims. However, if the big utilities start to aggregate wind farms, claims are likely to drop again. That is because the utilities have large retentions, often about $5 million. Claims and premiums are likely to go down for wind equipment.”

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Repair costs are also dropping, said Battenfield.

“An out-of-warranty blade set replacement can cost $300,000. But if it is repairable by a third party, it could cost as little as $30,000 to have a specialist in fiberglass do it in a few days.”

As that approach becomes more prevalent, business interruption (BI) coverage comes to the fore. Battenfield stressed that it is important for owners to understand their PPA obligations, as well as BI triggers and waiting periods.

“The BI challenge can be bigger than the property loss,” said Battenfield. “It is important that coverage dovetails into the operator’s contractual obligations.” &

Gregory DL Morris is an independent business journalist based in New York with 25 years’ experience in industry, energy, finance and transportation. He can be reached at [email protected]