Insurance-Linked Securities Report 2008 - Aon

Aon Capital Markets
CME Group developed three types on contracts for hurricane futures and
options in six defined U.S. areas: Gulf Coast, Florida, Southern Atlantic
Coast, Northern Atlantic Coast, Eastern U.S., and Galveston-Mobile. The
contracts are also listed in terms of numbered events (e.g., first hurricane
of the season to make landfall, second hurricane, etc.). The value of each
future will be 1,000 times the value of the CHI. The contracts trade on the
CME Globex ® system.
According to Carvill, the nominal value of derivatives traded since its
inception has reached nearly $60 million, making the CME derivatives as
successful as IFEX ELFs. With the multiple defined areas available as a basis
for the futures and options, theoretical basis risk is reduced versus ELFs.
• Re-Ex Index.
Gallagher Re, now a part of Aon Re Global, launched the Re-Ex Index in
2007. The Re-Ex Index was created by taking Property Claim Services (PCS)
loss damage estimates and dividing by $10 million. For example, if the PCS
estimate totaled $25 billion, the Re-Ex Index would be $2,500. Aon adjusts
the underlying PCS data only to eliminate losses related to earthquake and
terrorism. Three indices are offered, including Nationwide, Texas to Maine
(excluding Florida) and Florida itself. The Re-ex index includes losses up to
the end of a calendar year, plus a three-month development period. Thus,
the settlement date for the index is March 31 of each year. Note that the
Re-Ex Index is cumulative over the course of the annual period.
NYMEX offers Cat Risk Index Contracts based on the Re-Ex Index. The
contracts are standardized futures and options with some commercial
terms modeled on ISDA terms. They are financially settled against the
Re-Ex Index by taking the Index value and multiplying by a contract value
of 10. In the example above, if the Re-Ex Index was $2,500 on a settlement
date, contracts would be settled at $25,000. The variety offered by Re-Ex’s
three indices creates the ability to trade contracts specific to one of the
three geographies, or a combination.
The contracts are executed off-exchange in the OTC market, and cleared
through NYMEX’s ClearPort ® system. Unfortunately, volumes to date
have been low and the resulting activity level has not provided sufficient
price information for an analysis of the contracts’ economics. However,
market participants should be encouraged by the development of
the index and associated contracts, as they offer another method for
hedging catastrophe risk. The contracts’ association with well-established
stakeholders such as PCS, NYMEX, and Aon also provides them strength
and market acceptability.
NYMEX contracts offer a theoretically lower level of basis risk vis-à-vis
IFEX contracts by virtue of the three specialized geographic indices. The
proposed creation of additional IFEX contracts will temporarily minimize
this advantage until additional specialized contracts can be created by
either player, based on demand.
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