Today, nearly half of Florida's home insurance is provided by companies whose primary profit comes not from insuring homes but from diverting premiums into a host of side ventures.
Investors and executives in 2008 moved $1.9 billion in policyholder money out of heavily regulated insurers, where profits are capped and dividends are restricted, to separate companies that are owned by the same people, housed at the same address and sometimes use the same employees.
As soon as the money is moved, it is beyond the reach of homeowners who might need it to rebuild after a disaster.
It is also free to be paid to investors and owners as profit without interference from regulators.
Meanwhile, insurance executives complained about losses and state-mandated discounts, and pressured state regulators for permission to charge homeowners more -- even to end rate regulation altogether.
The payments to themselves, by and large, were legal.
As Allstate and State Farm have fled the state and left homeowners scrambling for coverage, Florida lawmakers have intentionally relaxed rules designed to police insurance company profits. Regulators hoped the promise of profits would persuade investors to start more insurance companies.
The Herald-Tribune spent more than a year investigating the Florida insurance industry, including reviewing the financial filings of more than 70 Florida-only companies that now provide nearly three-quarters of the private property insurance in the state.
It found that:
• Overhead costs -- expenses not related to hurricanes or other disasters -- are 50 percent higher in Florida than the national average. The higher overhead cost Florida homeowners an added $900 million in 2009 alone.
• In cases where the Herald-Tribune could see both sides of the ledger, the overhead charges were inflated. Of the $72 million in management fees that Southern Oak paid its affiliate over five years, nearly half -- $35 million -- was profit, insurance regulators now say. Three other carriers paid themselves an average 44 percent profit.
• Some insurers devote so much of their premium to reinsurance and paying related companies they have little left for claims. Even in its first months of operation, state financial examiners said, American Keystone was structured to spend more than it collected.
• Insurers have contracted so much of their work to unregulated sister companies that some are essentially shell operations with few employees. Homeowners Choice, for instance, pays one affiliate to negotiate reinsurance contracts and another to manage policies, and buys catastrophe protection from a third.
• Lax state rules encourage executives to pay sister companies as much as possible. The Legislature barred regulators from requiring insurance affiliates to report their finances.
• Even while complaining of losses, Florida insurers from 2006 through 2008 paid $38 million in bonuses and $32 million in other perks to 180 of their officers.
The state industry's chief trade group, the Florida Insurance Council, defends internal deals as a way to provide quick returns to start-up insurance companies. Regulators bar insurance companies themselves from paying dividends to investors until they have been in business at least three years.
"Investors would simply not provide funding without generating some return each year as they are putting up money with a risk of total ruin," said Sam Miller, vice president of the council.
Others say self-dealing increases the chances of ruin.
"The companies are taking profits out as opposed to keeping it for future losses," said Frank Cacchione, CEO of TNC Management, a New Jersey company that sometimes audits insurers' books for private reinsurers. "When the insurance company fails, they haven't lost any money. In fact, they've made a lot of money."
HOW INSURERS GUARANTEE PROFITS
Most of the money redirected from insurers -- $710 million in 2008 alone -- goes to companies called managing general agents, or MGAs, which run insurers' day-to-day operations.
Part of these fees pay legitimate expenses, such as agent commissions. But a yet-unpublished analysis by the Insurance Consumer Advocate, an independent state position created by the Legislature, found that Floridians pay 50 percent more for overhead costs than the national average.
Florida residents paid an average of $434 per policy toward insurers' operating expenses, the analysis found. Across the nation, the average was $289.
And because MGA fees are set as a percentage of total premiums, when insurance companies get rate increases, the MGA fee also goes up. Regulators in December granted Olympus Insurance a 25 percent increase to cover reinsurance. The advocate's office objected, noting Olympus already has one of the highest expenses of Florida insurers. The MGA would automatically receive $2 million of the $11 million rate boost for no added work.
"Do these functions cost more in Florida than the rest of the country? I don't think so," said Advocate Sean Shaw. "But somehow this is happening."
The Florida Insurance Council defends MGA profits. After surveying some of its members, the trade association said MGA profit margins are only 3 percent to 5 percent of total premiums -- an amount vice president Sam Miller said "is not considered excessive and does not involve a great amount of premium."
However, calculating MGA profit as a percentage of MGA revenue -- the traditional way of figuring business profit margins -- shows MGA profit margins ranging from 25 percent to 50 percent.
SIDE VENTURES TURN LOSSES INTO PROFITS
Because Homeowners Choice, an insurer based in Clearwater, is publicly traded and must file financial reports with the Securities and Exchange Commission, it offers insight into how self-payments work.
Financial statements filed with insurance regulators show the insurer posted a $5.6 million loss for the first nine months of 2009.
"We did?" asked Jay Mahdu, the vice president of marketing and investor relations for the two-year-old company.
He was more familiar with Homeowners' holding company filings with the SEC, which at the time showed a $10 million profit.
(Year-end reports filed earlier this month reported 2009 losses of $650,000 for the regulated insurance company and 2009 profit of $11 million profit for the holding company.)
"There is so much business in Florida that, managed well, you can do very, very well," Mahdu said.
Homeowners Choice turned an insurance "loss" into a stockholder profit mainly in this fashion:
Homeowners Choice paid Homeowners Choice Managers $24 million (and $2 million more to others) in 2009 for management services that cost $15.4 million.
It paid $9 million to Bermuda-based Claddaugh for reinsurance, almost all of which was likely profit because, according to state regulatory filings, none of it was used to pay claims.
Homeowners concedes its profits come from itself, but says the money is pumped back into the insurer as capital contributions that allow it to offer insurance to more Floridians.
"We haven't taken any money out," Mahdu said. "It's all about growth for us."
Homeowners has issued no dividends to investors, but three company directors collected $1.4 million by charging for services through their own private ventures.
In 2008, Homeowners Choice paid $400,000 to lease its computer billing system from a software company owned by Paresh Patel, founder of Homeowners Choice. The contract requires that Patel's insurance company is the firm's only client. Patel was also paid a total of $525,000 in bonuses for the past two years.
Another owner/director, developer Gregory Politis, leases Homeowners part of the third floor of a Clearwater office building he owns, for $150,000 a year. And in 2008, Homeowners paid $643,000 for legal services from the firm of another director, Martin Traber.
Mahdu said the many Homeowners Choice subsidiaries are the artificial construct of corporate attorneys.
"There is no such thing as the division. A Homeowners employee is a Homeowners employee," he said. "At the end of the day, we live and die on the bottom line. It doesn't matter which entity posts a profit or loss."
PAYING AFFILIATES FOR BACKUP COVERAGE
One way insurers move money out of the regulated business is by forming their own reinsurance companies. Essentially, they sell insurance to themselves.
In 2007, one of the reinsurers with which United Property and Casualty did business was a Grand Cayman Island reinsurer called Caymaanz.
What made the transaction stand out was how much United paid for reinsurance from Caymaanz.
In return for $6.5 million in storm protection, the Florida property insurer paid Caymaanz $6.5 million -- $5.5 million for the coverage and $1 million for the purchase of Caymaanz stock.
If there had been a hurricane, United would have gotten back essentially what it paid in. Without a storm, Caymaanz and its owners walked away with an untaxed, unregulated profit. Don Cronin, chief executive of United, said he did not remember what United made on the deal.
One of the Caymaanz owners was also a United director. Florida incorporation records show Caymaanz is owned by a Tampa workers compensation insurer named Sunz. One of the Sunz Group directors, according to the records, was Ocala horse feed manufacturer Greg Branch -- at the time also the chairman of United Property and Casualty.
United did not report the transaction as an affiliated purchase because, said Cronin, "it didn't meet the technical definition."
No-risk reinsurance deals in which firms basically pay up front what they expect to collect were at the root of former New York Attorney General Eliot Spitzer's financial fraud investigations of the insurance industry in 2007. In the aftermath, regulators adopted restrictions on such deals.
Cronin said the Caymaanz contract passed that test because it also included prepaid coverage for a second hurricane. Under the right conditions, Cronin said, United could have collected $13 million, twice what it paid for the coverage.
He would not say who arranged the transaction, but said Branch, chairman of United's board and chairman of Sunz's reinsurance committee, abstained from the board vote approving it.
DEAL HELPS BANK, BUT NOT POLICYHOLDERS
While it is common for Florida-only insurers to do business with themselves, Hillcrest Insurance did a deal with its founder that cost policyholders.
In early 2009, according to filings with the National Association of Insurance Commissioners, Hillcrest Insurance bought $600,000 in bank stock from the insurance company's founder, Vernon D. Smith.
Seven months later, the stock -- in a banking group that Smith owned -- was written off by the insurer as worthless.
The purchase is noted in the quarterly NAIC financial filings. Hillcrest's March 31 report to regulators identified Smith as the "vendor" who sold it the stock, while other filings describe the shares as coming from a company director.
Smith did not return phone calls to his home. Neither did his daughter and son-in-law, who serve as Hillcrest's chairman and CEO.
They formed Hillcrest in 2005, with 90 percent of its ownership coming from a family trust that state incorporation records show Vernon D. Smith controlled.
Smith was regarded as a pillar of Florida's community banking scene. Over decades he had organized three different "Riverside" banking groups with branches stretching from St. Augustine to Cape Coral. He was a major donor for Indian River Community College, owner of a small newspaper chain and adviser to the Florida Highway Patrol.
But at the time of the stock purchase, Smith's Riverside banking empire was in trouble. One group was beset by financial rating downgrades and bad loans, another was closing offices, and the third was seized by the FDIC.
It was in that environment that Hillcrest reported to the National Association of Insurance Commissioners that it paid $600,000 for 4,000 shares of stock in Riverside Banking Co.
By September, the insurance company wrote off that purchase, declaring the stock worthless. The company's filings show the write-down contributed to a $680,000 loss that September. To pay its bills, Hillcrest pulled money from its policyholder surplus, reducing the amount of money set aside to pay future claims.
The Herald-Tribune also attempted to reach Smith and his family through their insurance company, without success. There is no Hillcrest office to contact. The company pays the Tower Hill insurance group to run its business.
"We're what you call a 'virtual operation,'" said Hillcrest chief finance officer William Thompson, who earns his $172,000 salary working from Tallahassee.
Subsequently, on Dec. 21, Hillcrest sold the shares to a charity. The reported buyer, Big Brothers Big Sisters of St. Lucie, paid $1,000.
EXECUTIVES ACCUSED OF STRIPPING MILLIONS
Florida homeowners are still paying the $810 million bill for the failure of the Poe Insurance Group, the costliest property insurance failure in state history.
State investigators now believe the bailout was made worse by executives grabbing tens of millions of dollars before regulators could close the deteriorating company.
They did it by funneling money into unregulated sister companies, steering the money to investors and owners instead of to homeowners, according to allegations laid out in a civil court case filed by Florida Insurance Receiver's office in Leon County Circuit Court.
Over four years, through what the court complaint alleges was a "fraudulent scheme," Poe founder and former Tampa Mayor William Poe Sr. received more than $30 million. Another $1 million went to his nonprofit foundation.
In addition, instead of paying hurricane claims, Poe's managing agency paid off $25 million in debt for which Poe was personally liable and kept $35 million in premium fees it did not earn, the complaint states.
That money could have helped thousands of Poe customers left with worthless insurance after the 2004-05 hurricane season and forced to seek payment through a state solvency fund. Instead it enriched company insiders or softened their financial losses, the state argues.
Attorneys for the Poe family would not comment, citing pending litigation. But statements made in court show that while they contest the allegation of fraud, they do not dispute the amounts taken -- just whose money it was. They contend the family put most of what was not eaten up by taxes back into the insurer.
"There is no insurance company monies that ever went to the Poes," attorney Harley Reidel said in a court hearing last year.
The Poe family has responded by filing for bankruptcy protection and seeking federal court orders barring the state from pursuing its claims in circuit court.
The insurers left behind $1.5 billion in policyholder claims and less than half the money needed to pay those bills. Florida consumers are on the hook for the rest, as fees on their own home premiums from the Florida Insurance Guaranty Association.
LOOPHOLE LETS PROFITS SLIP THROUGH
Florida's Office of Insurance Regulation polices almost every aspect of the insurance industry.
But when it comes to following the money paid to affiliates, the OIR is largely benched.
Lawmakers intentionally made it so.
Like most states in the mid- 1990s, Florida adopted model laws aimed at regulating how insurers use managing companies called MGAs.
But in Florida, the Legislature added words excluding the most common kind of managing agent in the state, those controlled by the insurance company's owners.
So there are laws that require managing agents to charge a fair rate and allow regulators to audit their books, and laws that impose penalties for violators.
But those laws do not apply if the insurance company owners form their own MGA and charge themselves for the services.
"Enabling insurers to have wholly owned MGAs operate without oversight, that's what I see is the problem," said Shaw, the insurance consumer advocate.
Florida's insurance industry trade group says regulators and insurers have worked out a compromise -- inserting language into management contracts that stipulate regulators have a right to look at certain financial reports.
Officials at the Office of Insurance Regulation refused to say how often they conducted such reviews, contending it was a "legal research question" the agency did not have resources to answer.
At least twice, the agency has ordered insurers to reduce their MGA fees. In the case of First Home, affiliates were also ordered to return $1.3 million in management fees.
On Tuesday, Southern Oak was ordered to show why it should not be required to return $10 million in "excessive profit," a portion of the $35 million in profit regulators said the MGA made off the insurer since its inception in 2004.
Southern Oak CEO Tony Loughman said those profits were "consistently" invested back into the insurance company. Annual financial filings show Southern Oak paid $72 million to its managing agent since 2004, returning only $12.6 million.
A second order, signed Friday, allowed Southern Oak to keep its MGA commissions as they are, but to return a portion of them if the insurer loses money.
The fees OIR sought to restrict were approved by the agency in 2004 -- when the company was launched by a former candidate for governor, Stephen Pajcic, a prominent Democrat who also owns a Jacksonville law firm -- and again in 2005 and 2007.
In interviews, the state's insurance solvency chief said that in the past, her office did not look at the flow of secondary profits through affiliates, because it allowed company owners to pay off their own loans used to start the insurer.
Allowing these profits "facilitated more capital to our marketplace" said Robin Westcott, solvency director for the agency's property insurance division.
OIR is now paying more attention because, she said, "it can be manipulated to take money out of the companies."