Catastrophe Futures

Financial instrument traded on the Chicago Board of Trade (CBOT). By purchasing this future, the insurance company can hedge its risk exposure against possible future catastrophic losses. The CBOT releases a report each quarter showing on a state-by-state basis the premium amount and the line of insurance that has a catastrophic exposure. Each future contract has a stated value of $25,000 multiplied by the catastrophe ratio for that particular quarter. This multiplied result forms the basis for beginning to trade the quarterly catastrophic futures contract on the CBOT. If there is a high level of catastrophes such that the actual catastrophic loss ratio is greater than the expected catastrophic loss ratio, the futures contract increases in value and the insurance company purchaser gains the difference between the initial purchase price and the quarterly ending value of the contract. Conversely, if there is a low level of catastrophes such that the actual catastrophic loss ratio is less than the expected catastrophic loss ratio, the futures contract decreases in value and the insurance company purchaser loses the difference between the initial purchase price and the quarterly ending value of the contract.