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MARK AUSTIN THOMAS: If you’re a regular listener of Marketplace you know that we play this when the markets are down:
[ Music: Stormy Weather ]
Well today stormy weather will hit the markets but not in the way we usually mean. This morning hurricane futures start trading on the Chicago Mercantile Exchange. For more here’s Marketplace’s Dan Grech:
DAN GRECH: Let’s say you’re an energy company in the Gulf Coast and a hurricane’s headed your way. You’ve insured your oil pipelines, but it might not cover all your losses.
In the past, you had to live with that risk. Now you can buy hurricane futures and get a nice payout if a big storm hits.
If the hurricane’s a dud, you lose your initial investment. That’s just the gamble you take.Robert Hartwig’s with the Insurance Information Institute.
ROBERT HARTWIG: The objective here is to hedge risk. In other words, try to put a limit on the uncertainty associated with events that we don’t know exactly how they’ll turn out in the future.
Utility companies, state governments, even insurance companies themselves may use futures to reduce their exposure.
Futures have one big advantage over traditional insurance: while claims can take months, futures contracts close in three days.
The Chicago Mercantile Exchange decided to create a hurricane futures market after the heavy 2005 season. But the Merc ran into a problem: The familiar Saffir-Simpson scale, which puts hurricanes in Categories 1 through 5, wasn’t precise enough.
STEVE SMITH: Calling something a strong Category 4, for example, is very subjective.
That’s meteorologist Steve Smith with Carvill, a company that tracks hurricane activity. He teamed up with the Merc to develop a brand new index that takes both wind speed and storm size into account.
SMITH: A simple formula that people understand and is repeatable and transparent. And that’s really what we were trying to do with this index.
Each point on the index is worth $1,000. Hurricane Katrina was a 19 — if you bought a Katrina future, you’d be paid $19,000 when it hit.
The Merc’s Rick Redding says a futures market could eventually benefit homeowners.
RICK REDDING: What we’re trying to do is bring more capital into the marketplace. That market will become more efficient, and typically, that would lead over time to lower insurance premiums.
Truth is, no one’s sure if a hurricane futures market will be successful. Robert Hartwig:
HARTWIG: It’s sort of a wonderful economic experiment that we’re about to see unveiled in the 2007 hurricane season.
I’m Dan Grech for Marketplace.
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