Dual trigger
A mechanism making a payment conditional on two conditions being met at once, usually a market event or parameter and an actual loss by the insured, to limit basis risk while keeping the speed of an index.
A single index-based trigger has two virtues, speed and no disputes, and one flaw, basis risk: the buyer may suffer a loss without the index triggering, or receive a payment without having lost anything. A trigger based solely on actual loss has the opposite virtues and flaws. The dual trigger combines both. Payment is due only if an objective parameter crosses a threshold and the insured has actually suffered a loss. Three uses dominate. In energy, a generator is paid if a plant breaks down while the market price of electricity exceeds a threshold, because it is the combination that ruins it: it must then buy at a high price the power it had committed to deliver. In reinsurance, an industry loss warranty often requires the buyer to prove its own loss in addition to the index being breached, which keeps the contract within insurance. In corporate finance, a cover may require both a catastrophe and a drop in revenue. The requirement of an actual loss also has a legal function: it establishes insurable interest, which distinguishes an insurance contract from a wager or a derivative.
Hypothetical case: a power producer buys a cover paying 5 million euros if its main plant is down more than 72 hours while the wholesale price exceeds 300 euros per megawatt-hour. A breakdown during a cold snap meets both conditions; a breakdown in a low-price period would have triggered nothing.
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