The Chicago Mercantile Exchange, the largest derivatives exchange in the United States, announced last week that it is launching contracts that will allow insurers and others to hedge risk against hurricane damage.
The exchange, a unit of CME Holdings Inc., is teaming up with Carvill Group, a reinsurance intermediary that will calculate the contracts’ underlying indexes of hurricane data used to calculate damage. Front contracts will expire when a storm makes landfall, with expiration pegged to the index.
CME said contracts for “CME-Carvill Hurricane Index” futures, and options on futures, will begin trading on the floor and on the Globex electronic platform on March 12.
“Following the 2005 hurricane season that caused an estimated $79 billion in damage, it became apparent that there was limited capacity to insure customer claims,” said Felix Carabello, director of alternative investment products at CME, in a release. “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.”
CME’s announcement follows one by Nymex Holdings Inc., which will list three new catastrophe risk index futures contracts in March. The Nymex contracts will also trade on CME’s Globex, per an agreement between the two exchanges reached last year.
The move to list alternative investment contracts is a relatively new development for the exchanges as they seek a wider group of market participants. CME currently lists weather contracts based on temperatures in 35 cities worldwide as well as snowfall and frost indexes. Nymex began trading property damage risk contracts last month.
The exchanges’ new risk products provide another way to hedge risk in an area that has primarily been the domain of insurers. In addition to insurers, CME also sees demand from customers such as energy companies, pensions funds, state governments and utility companies.
The new hurricane contracts will be available in five areas defined as the Gulf Coast, Florida, the Southern Atlantic Coast, the Northern Atlantic Coast and the Eastern United States.
Carvill will calculate the underlying indexes using publicly available data from the National Hurricane Center of the National Weather Service. The Index uses the maximum wind velocity and size, or radius, of each official storm to calculate the potential for damage.
The hurricane contracts are part of the CME’s push into a broad array of product areas. The exchange offers futures and options on futures on interest rates, stock indexes, foreign exchange, agricultural commodities and energy.
In addition to weather contracts as an alternative investment, CME offers housing derivatives on residential real estate.
The company plans to merge with CBOT Holdings Inc. mid-year.
Shares of CME Holdings rose $1 to close Wednesday at $573 on the New York Stock Exchange.
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