Catastrophe index futures
Exchange-traded contracts whose value depends on a catastrophe loss or intensity index, designed to transfer catastrophe risk the way interest rate or commodity risk is transferred.
The idea is old and appealing: standardize catastrophe risk into listed contracts that are liquid and cleared through a clearinghouse, which would remove counterparty risk and contract-by-contract negotiation. The contract settles on an index, market insured losses or a physical measure of the event, rather than on the buyer's own losses. It therefore transfers risk quickly but leaves the insurer with basis risk, the gap between the index and its own loss. That basis risk, together with the lack of natural sellers and liquidity that never took hold, explains why these markets have repeatedly failed. Tailored reinsurance and cat bonds kept most of the transfer.
The Chicago Board of Trade launched catastrophe futures in December 1992, after Hurricane Andrew, then options on Property Claim Services indices in 1995, which were withdrawn for lack of volume by the end of the decade. In March 2007, the Chicago Mercantile Exchange revived the idea with contracts on a hurricane index computed from wind speed and the hurricane's radius at landfall.
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