You can now bet on hurricanes through Chicago Mercantile Exchange
Mar 13, 2007
By Joseph Mann
South Florida Sun-Sentinel
Posted March 12 2007
You can now use the futures market to bet on hurricanes.
Starting Monday, the Chicago Mercantile Exchange began offering contracts covering the arrival of the first three hurricanes in Florida and four other coastal regions during the 2007 hurricane season. These contracts, which are an extension of the CME’s existing weather contract market, provide insurance firms, oil companies, utilities and others an opportunity to cover risks not protected by traditional insurance policies.
A contract essentially works like this. After a storm begins forming off the coast of Africa, for example, a buyer can obtain a contract covering the first storm to make landfall in Florida. The risk level of the storm will be determined by a sliding scale – the CME Carvill Hurricane Index – that takes into account the size of the hurricane, maximum wind velocity and damage potential. The scale starts at zero and rises as the storm becomes larger and more powerful.
If the storm approaches any part of Florida and becomes a higher category hurricane, the index rises. Thus, a contract purchased when the index was at 2, for example, at $2,000, would be worth $10,000 when the index rises to 10. The futures owner can hold onto the contract at $10,000, or sell it for a higher price if the risk increases.
If the contract is worth $10,000 and the hurricane strikes Florida, the holder can obtain $10,000 cash within a few days. This compares to traditional insurance policies where claims may not be settled for months.
However, if a hurricane does not strike land in Florida during the 2007 season, a contract – whether it cost $2,000 or $10,000 or more – is worthless. The hurricane season runs from June 1 through Nov. 30.
“Following the devastating 2005 hurricane season that caused an estimated $79 billion in damage, it became apparent that there was limited capacity to insure customer claims,” said CME alternative investment products director Felix Carabello. “With these hurricane contracts, insurers and others will be able to transfer their risk to the capital markets and thereby increase their capacity to insure customers.”
“This solution is not for everyone,” warned Robert Hartwig, president of the New York-based Insurance Information Institute. “This could be complementary to some reinsurance products, but it remains to be seen how successful it will be. I’ll be interested in seeing who the players are in this market.”
Speculators could exert a negative effect by increasing volatility, Hartwig warned.
On Tuesday, there were no CME trades in hurricane futures. In 2005, the Iowa Electronic Markets and the University of Miami’s Rosenstiel School of Marine and Atmospheric Science opened a small hurricane futures market limited to academics.