Every year, about 47,000 property owners on the coast of South Carolina pay millions of dollars to a special insurance organization that funnels nearly all of this money to a group of super-wealthy companies in Bermuda, Switzerland and other far-flung locales.
Welcome to the Byzantine world of the "wind pools," where rates are set high on purpose and insurers spend millions to insure themselves.
Most coastal states have wind pools — government-chartered nonprofits that insure high-risk homes and buildings no private insurance company wants to cover.
And some have become massive enterprises. Florida's wind pool, Citizens Property Insurance Corp., insures 1.4 million properties and collects $3 billion in premiums a year.
South Carolina's smaller iteration is the S.C. Wind and Hail Association, which every year collects nearly $100 million in premiums from 46,000 homeowners and 1,000 commercial property owners in two zones near the water.
In Charleston County alone, it insures about 10,000 properties valued at $4 billion. On average, owners shell out about $2,040 for coverage against wind and hail damage. That doesn't include coverage for fires and flooding, which requires separate polices.
"I'm paying almost $5,000 for all my insurance now," said George L. Williams, a retired veteran from the Isle of Palms whose home is in one of the wind pool zones. "Really and truly, I would like someone to explain what's going on with the money."
Some consumer advocates say wind pools reflect a troubling trend: Private insurance companies are shifting high-risk properties to these groups and keeping "the safest risks for themselves," a report by the Consumer Federation of America said this year.
"It is akin to solving the health insurance crisis by requiring states to cover sick or terminally ill patients, while the private sector writes coverage for young and healthy consumers," the report said.
Others say wind pools have helped prevent real-estate meltdowns in hurricane-prone areas by giving homeowners another option to buy wind hazard insurance, even though it's expensive.
What is clear is that as private companies such as Allstate and State Farm pull out of areas near the ocean, wind pools have emerged as significant players in coastal states such as South Carolina, even though, as Rick Amick, chief financial officer of the S.C. Wind and Hail Association, said, "We like to fly under the radar."
What are wind pools?
The wind pool's roots stretch back to a double-whammy of fear during the 1960s.
After inner-city riots, insurers grew nervous about covering homes in urban areas. States responded by creating FAIR plans, short for "fair access to insurance requirements," to cover properties that private insurance companies dropped.
At the same time, insurance companies grew anxious about their potential losses in a hurricane strike. The federal government responded by creating the National Flood Insurance Program in 1968; states followed by forming wind pools.
In 1971, South Carolina lawmakers ordered insurers to set up the S.C. Wind and Hail Association. Only people in specially designated zones near the ocean are eligible for wind pool coverage.
Though created by state statute, the association is run by the insurance industry, including many insurers that are canceling policies. The association's board comprises 11 insurance company officials, two insurance agents and four consumer representatives.
The association is funded by the premiums it collects from property owners. Much of the legwork with customers is done by traditional insurance agents who last year received $9 million in commissions from the association.
Unlike the federal flood insurance program, the South Carolina wind pool receives no money from taxpayers. In the event of a catastrophe, taxpayers wouldn't be on the hook for claims.
Its small staff works out of an office in Columbia, and one of its main goals is to provide insurance rates that are so high they don't compete with traditional insurance companies like State Farm and Allstate.
"We don't want to push companies out of the market, but we do want to be a safety net," said Smitty Harrison, the longtime head of the association. "It's a bizarre business model. We want our competition to take our business."
Although the wind pool collects $97 million a year from South Carolina property owners, it insures more than $17 billion in property. It has no reserve fund to speak of.
That presents the group with a major problem: If a catastrophic hurricane made a direct hit on Charleston or Myrtle Beach, the group would never have enough to cover losses, Harrison said. For this reason, the wind pool must go outside South Carolina to find ways to pay for a future catastrophe.
And it does this by taking out insurance policies of its own.
Masters of disaster
Insurance is about spreading risk, and it has a long tradition. Ancient traders increased their odds of getting materials to destinations by spreading cargoes among different ships and caravans.
Today, a relatively small group of wealthy reinsurance companies across the globe do something similar for insurance companies and groups such as the S.C. Wind and Hail Association. In South Carolina, of the roughly $97 million in premiums that were collected in 2011, about $85 million went toward reinsurance.
The world's 200 reinsurance companies have become global masters of disasters, taking in vast sums of money in Europe to help insurers in the United States pay for a devastating tornado strike in Oklahoma, or using billions of dollars from insurers in the United States to help pay for losses of a tsunami in Japan.
Every year, these companies collect more than $200 billion in premiums from insurance companies and wind pools.
And the insurance industry is quick to say we would be in trouble without them. After hurricanes Rita and Katrina in 2005, reinsurance companies sent billions of dollars to private insurance companies, which in turn paid homeowners with claims.
According to the reinsurance giant Swiss Re, reinsurance companies were responsible for paying 60 percent of those hurricanes' claims.
Ten reinsurance companies control three-quarters of the market. Munich Re is the largest with 15 percent, and it is expected to make $3.1 billion in profits this year. Because such a small number of companies are involved, some are concerned about the potential for price fixing.
A European Commission report in 2007 cited this possibility and noted that in some European countries, reinsurance companies may control half the market or more. "In other market sectors, such a concentration of market share would be likely to trigger a monopoly investigation."
Robert Hunter, a former insurance commissioner from Texas now with the Consumer Federation of America, said reinsurance companies in Florida were charging five times more than what their own actuaries said they needed.
In response, Florida has been building a hurricane catastrophe fund, now at $15 billion, a move that helped homeowners save $20 billion on their policies in recent years. But in South Carolina and many other states, wind pools are at the mercy of whatever the reinsurance industry decides to charge, he said.
Selling South Carolina
Every year, Harrison and other staff members with the S.C. Wind and Hail Association travel to reinsurance meetings in London, Bermuda and other reinsurance hot spots. The wind pool's job, Harrison said, is to sell these companies on the argument that South Carolina's coastal homeowners are worth covering and that the state's wind pool operates in a responsible way.
Harrison said their sales pitches have worked well over the years, even though the reinsurance industry tends to look at state wind pools as bad overall risks.
Of the 99 reinsurance entities the state works with, about 80 have decided to cover potential wind pool losses. That means the wind pool effectively spreads the risk of a devastating hurricane hit to 80 companies. Average premiums have risen only 14 percent since 2007.
David Marlett, chairman of Appalachian State University's Department of Finance, Banking and Insurance, has studied wind pools throughout the Southeast since 1998.
Other states have set up special catastrophe funds or systems to assess property owners and insurers after a storm. Both approaches have problems. A catastrophe fund could be wiped out quickly in a major storm, and when it comes to assessments, "you're basically asking people who have just had a major loss to pay more money," Marlett said.
Reinsurance may be expensive, but it takes care of the problem of covering high-risk properties, he said, adding that Harrison and his team have an excellent reputation in the industry.
"I'm comfortable saying that over that time period, the South Carolina wind pool has been one of the best, if not the best, managed residual market program in the country."
That's small comfort, however, to customers in wind pool zones who have seen their rates skyrocket — people like Susan and John Watkins.
Feelings of betrayal
The couple has lived off Camp Road on James Island for 37 years. In 1989 they stayed in their house during Hurricane Hugo and lost only 12 pine trees and a corner of their roof. They had insurance with State Farm then, and switched to S.C. Farm Bureau when they refinanced.
"In 2007, all of a sudden they dropped our wind and hail coverage," Susan Watkins said. "They said it was because of increased hurricanes and something called reinsurance." Like others who have been dropped, she felt betrayed.
"It's like they're really into risk avoidance instead of risk insurance." She called the Department of Insurance. "They were not very nice," she said. "All they told us was that we would have to get insurance from the wind pool."
Her last bill from the S.C. Wind and Hail Association was $3,200, and that didn't include coverage for floods and other hazards.
"It got to the point where it was ridiculous," she said. She and her husband recently found a private insurance company willing to write a policy for about $2,800. But the high rates are still tough to swallow for retirees. "It's just killing us, and being in the wind pool zone puts a stigma on us when we have to sell our property," she said.
'Market of last resort'
In a sense, though, their experience is a wind pool success story.
Staff members with the S.C. Wind and Hail Association want private insurance companies to take business away from them.
"We are truly trying to remain a market of last resort," Amick said. At the same time, they're trying not to create too heavy a burden for homeowners.
They acknowledge that setting rates is a bit of an art form. If the wind pool gets a huge influx of homeowners seeking policies, that usually means the group's rates are too low, said David Leadbitter, chief operating officer. If rates are too high, homeowners complain.
"No computer can figure this out, but if you screw it up, you know the effects immediately," he said.
One sign that the market has stabilized is that the number of policies has stayed around 47,000 for several years.
Black boxes and rates
The problem homeowners face is that rates are likely to continue going up because reinsurance companies are reassessing their vulnerabilities to disasters, Leadbitter and other experts say.
That's because insurance industry computer models are predicting higher losses.
The models, dubbed "black boxes" because of their secret algorithms, have their critics, including some who say they overstate the risks and make it easier for insurers and reinsurers to charge higher rates.
Karen Clark, the architect of the first catastrophe computer model, said she found new models have overestimated losses by as much as $53 billion.
A Post and Courier report this month found that South Carolina regulators have little knowledge about the inner-workings of these models and whether they properly assess risk in South Carolina. Other states have found major flaws in models when they looked at them.
Meanwhile, as South Carolina heads into the heart of another hurricane season, homeowners in coastal areas remain in precarious positions.
Their rates are subject to reinsurance giants oceans away; state lawmakers are doing little to support efforts to monitor the fairness of rates; and if their insurance company drops them they're left with what officials from the wind pool acknowledge is an unusual sales pitch: "We're not only expensive," Amick said. "But you get less coverage for your money."
Reach Tony Bartelme at 937-5554 and @tbartelme on Twitter.
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