How much is this going to cost me?
Over the years, we’ve encountered our fair share of companies grow beyond their “friends and family” round of financing to Series A, B, C and D rounds.
As time goes by and a cannabis startup continues to expand, more employees and investors are brought on board, revenues explode and the struggle to scale layers more complexity into the operation.
It’s growth and it’s a good thing! But it’s not always simple or easy.
With increased complexity comes a spike in risk exposure. Venture-backed companies (i.e. cannabis startups) are unique in the eyes of underwriters because they tend to grow beyond the expectations that come with more traditional companies. Yes, with risk comes reward…as well an increased cost of doing business.
Here are some factors that will affect your insurance costs for your cannabis company as you grow and scale.
Insurance policies are priced off a “rating basis” (or “exposure basis“) and “rate” at which the policy is priced. A common way to price a policy is using revenues where a rate of “x” per $1000 in revenue (with the revenue as the “rating basis”).
Let’s take an example. Say an underwriter is pricing an E&O policy for a cannabis startup.
Rate = $10 per $1000 of revenue
Rating basis: total revenue projected for the policy period = $500,000
E&O Premium = : 10 * (500,000/1,000) = $5,000
In the example above, we’re offered a premium of $5,000 with a rate of $10 per $1000 in revenues. Once we’ve discovered an underwriter with the best rate in relation to the quality of coverage, we’ll move forward and potentially place the policy.
But how does this equation affect your insurance costs as your cannabis startup grows? Well, one reason is obvious: as your revenues increase, so does your premium. The larger the rating basis, the larger the resulting premium.
In summary: companies firmly in growth mode can expect their insurance premiums to grow as well.
Losses and claims can have a substantial effect on your insurance premiums as your cannabis startup grows. An extensive history of claims will definitely drive premiums up. The flip slide? A clean loss history can work to the advantage of your company by driving your rate down over time.
So as your rating basis (which means your revenues) grow, your premium will grow, but not in an exact correlation. Let’s say the policy from the previous example is renewing except at renewal, your revenues are now $2M. The new premium quoted would be $11,500.
To break it down:
Rating basis: total revenue projected for the policy period = $2,000,000
E&O Premium = : $11,500
E&O Premium = : [rate] * (2,000,000/1,000) = $11,500
rate = $5.75 per $1000 of revenue
In the example above, you’ll note that the overall cost of the policy has doubled but the rate has practically been halved. This is not uncommon when it comes to renewals for growing VC-backed companies with clean loss histories.
The reason? With each passing year, the underwriter has more data to factor in. And even though it sounds a bit counterintuitive, the more revenue earned, the more the company is brought in alignment with the statistical models used to project losses.
Again, it’s a different scenario when there are either multiple claims or one or two substantial claims on the loss history. Premiums can be higher and rates are less likely to decrease.
In those scenarios, it’s best to focus on the adjustments that have been made to prevent similar claims in the future. This can ease the situation as well as show some good faith with the underwriter.
The takeaway: more experience is better (with loss-free experience being best of all!) when it comes to pricing out insurance policies as your cannabis startup continues to grow.
There are two types of insurance policy forms on the market: “occurrence” and “claims made.” Occurrence forms will cover your company as long as the occurrence has taken place within the policy period (or renewal policy period).
The other type is a “claims made” form, where a claim needs to be made against your company and reported within the policy period.
One could say that occurrence policies cover a snapshot in time. Even if the occurrence becomes obvious after the policy has expired, the company can still maintain its coverage as long as the policy was in place at the time of the occurrence. (With a claims made form, the policy must be in place to get coverage.)
The takeaway for your cannabis startup policy costs? If all factors remain the same or consistent, claims made policies are generally more likely to annually increase in price (even incrementally) because technically, the period of coverage is extending with each passing year.
This is not the scenario with occurrence-based policies (because your cannabis startup is paying for that snapshot of one year when renewal comes around).
Most general liability policies fall in the occurrence category but essentially all cyber, E&O, EPL and D&O policies are claims made. It’s not unusual for cannabis startups to see their general liability costs remain flat (with no rating basis change) whereas other policies see slight ticks of increase.
Carrier rating guidelines & market forces
When it’s all said and done, insurance is a financial product. And like any other financial product, macroeconomic trends and market forces can sway pricing…particularly losses.
For example, Hurricane Sandy devastated the east coast in 2012, causing extensive property losses for many insurance carriers. In 2013, we saw the market harden and rates spike across commercial insurance product lines, even D&O (a risk exposure completely unrelated to the property damage caused by the superstorm). Conversely, there’s recently been a flood of supply in the cyber market as more carriers introduce cyber insurance products. This has driven the cost of cyber down it the last year.
A similar scenario can occur when a carrier is too bullish on a product line or particular market sector. Or when products are priced too aggressively in a particular state. The losses can radiate beyond the company and increase the premiums of other lines of coverage. When this happens, we’ll work together to re-market your coverage so it can be placed with another carrier.
So as you may have noticed, there are a variety of factors that play into your insurance costs! It’s best to think of it like homeowners insurance. Let’s say you construct an addition to your house. It’s reasonable and predicable to assume premiums will increase, right?
You also might see rates go up if your neighborhood has been repeatedly hit by natural disasters. Consider these growing pains. For each new addition constructed, storm weathered or extra family member added, your overall output rises to outweigh the costs of insuring any potential downturn.
Wrapping it up
Figure it this way: these rising costs are a reflection of your cannabis startup’s future, mitigating risks and adding a layer support on your path to success. Talk to us to learn more about scaling your risk management program.