Look Into the Crystal Market

Hurricane market launches new contracts, could forecast future.

By Matthew Brodsky

The major hurricane forecasters have released their May seasonal forecasts, but for risk and insurance professionals wanting another gauge on the current cyclone season, started June 1, check out the Chicago Mercantile Exchange's Hurricane market.

From the same people who run weather futures trading, the hurricane futures market could prove to be a viable tool for reinsurers. CME launched the market on March 12, but trading volume had been nil from then to the time of this writing in April, according to Felix Carabello, CME's director of alternative investment products.

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But the CME, he said, was slated in May to release a new contract, based on hurricane landfall activity over the entire season. "I think that's what they've been waiting for," said Carabello about reinsurers.

If this contract jump-started activity in May as expected, the market could be a gauge of how reinsurers, energy companies and investors envisage the season's activity to play out. "The product can be used as a proxy for seasonal forecasting, given that people's impression, views, their psychology, will play into it," said Steve Smith, senior vice president at ReAdvisory, part of reinsurance broker Carvill.

The market's biggest value, of course, will still be its primary purpose--to allow reinsurers and energy companies to hedge against risk. "Because the markets have not had available for many years these types of risk mitigants, they've been helpless," said Carabello. "The difference going forward is, you know what the forecast is, and you know what these storms can do to your business. You have now the capability to really monetize what that risk means to your business."

Carabello predicted that the market would see some trading this year, followed by "really rapid growth" next year.

The market's original (and still available) contracts are based around landfall of individual storms in five U.S. coastal regions--for instance, first Gulf Coast storm, first East Coast storm. These contracts close when a hurricane runs ashore.

The market bases contract values on the Carvill Hurricane Index, a formula devised by the broker to measure a storm's total destructive value based on maximum sustained wind speed and storm size.

June 1, 2007

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