Subject: cme and catex
- - - - - - - - - - - - - - - - - - - - - - forwarded by joseph hrgovcic / hou / ect on 04 / 05 / 2000
04 : 06 pm - - - - - - - - - - - - - - - - - - - - - - - - - - -
lucy ortiz
04 / 05 / 2000 04 : 02 pm
to : joseph hrgovcic / hou / ect @ ect
cc :
subject : cme and catex
spotlight report
exchange products seeing slow trading
gavin souter
03 / 20 / 2000
business insurance
page 3
copyright ( c ) 2000 crain communications , inc . all rights
reserved .
exchange - based insurance products developed in recent years have
been somewhat slow to get off the ground .
although several exchanges have offered derivative contracts since
the mid - 1990 s to cover insurance risks , none so far has posted a
significant volume of trades .
few insurers , reinsurers or policyholders have been drawn away
from the traditional insurance markets , where capacity remains
abundant and relatively cheap .
as long as those traditional markets manage to weather major
natural catastrophes , the allure of the exchange - based products will
remain limited , observers say .
also stifling the growth of the exchange - based contracts is the
limited number of contracts available , one expert noted . dealers , he
said , are unable to secure a suitable hedge by laying off one
contract against another .
although the various exchanges have had a good opportunity to
establish a widely used set of new risk financing products , that has
not been achieved , said morton lane , senior managing director ,
capital markets division at gerling global financial products in
new york .
the main problem with the existing exchanges is that they do not
offer a sufficiently diverse array of products , he said . the only way
to control the risks in the catastrophe options is to have a diversified
portfolio of other contracts , and none of the exchanges currently
offers a sufficiently broad range of options to provide for that
hedge , he said .
florida windstorm options , for example , cannot be bought and then
hedged in the same way that international business machines corp .
stock options contracts can be hedged with ibm stock , mr . lane
explained .
the exchanges might be more attractive to investors if , in addition to
natural catastrophe options , they included options on other risks , he
said . those might include , for example , satellite , aviation and crop
indexes , mr . lane said . " for the insurance buyer , such exchange
instruments would not represent the perfect risk transfer vehicle , but
as long as they are quantifiable and indexable , they may represent a
good surrogate , " he said .
the exchanges could also be used to create a derivatives market for
over - the - counter securitized deals , if there are regular issuers of
catastrophe bonds , mr . lane said .
the soft insurance market has also hindered the growth of
exchange - based insurance products , said sean f . mooney , senior
vp and chief economist at guy carpenter & co . , the reinsurance
brokerage unit of marsh inc . in new york .
" the traditional market has been so competitive that people are not
looking for other ways of doing business , " he said .
at least in concept , the exchange - based deals are generally similar
to the mortgage - backed securities that have been a huge success
since they were introduced in the 1970 s . " there is a belief that
alternative means of transferring risks will grow , but it is difficult to
predict when , " mr . mooney said .
currently , the trading that is taking place typically involves
established insurers and reinsurers , so the exchanges have not
brought substantial new capacity to the marketplace , he said .
guy carpenter provided the index for the bermuda commodities
exchange reinsurance products . the bce did not take off ,
however , and was suspended last year after two years of little
activity .
the oldest of the insurance - related , exchange - based derivative
products are the catastrophe options traded on the chicago board
of trade , which began trading the options in 1996 .
initially , there was substantial interest in the options , but the soft
traditional market has hampered use of the contracts to hedge
catastrophe exposures , said carlton purty , an independent broker
at the cbot who trades in options .
no catastrophe option trades have been completed at the cbot
so far this year , he said . last year , there was increased interest in
the contracts because of hurricane floyd , but few contracts were
traded , mr . purty said .
" i think a major , major catastrophe will have to happen before they
really take off , " he said .
the contracts offer real protection , and options dealers are keen to
trade in a new niche , but the conventional insurance and reinsurance
markets are so soft that few companies are turning to alternative
coverage options , mr . purty said .
the catastrophe risk exchange , located in princeton , n . j . , has
radically changed its structure since it was originally announced in
mid - 1996 , and it is well positioned to expand , said frank sweeney ,
chief operating officer .
catex initially planned to be a computer - based facility for
reinsurers that would enable them to exchange catastrophe risks
and to build balanced portfolios .
but by the time the exchange was operational in november 1996 , it
was clear that most reinsurers and insurers interested in catex
wanted only to buy and sell conventional reinsurance , mr . sweeney
said .
although there was some interest in risk swapping , only a handful of
risks were posted on the system , and none was traded , mr .
sweeney said .
consequently , catex has become chiefly a " cash for cover "
exchange , he said , noting that the risks reinsured on the exchange
include property catastrophe coverage , aviation and liability
coverages . catex also trades industry loss warranties , where
coverage is triggered by an actual loss combined with an industry
loss over an agreed threshold .
other adjustments to the exchange included making it accessible
through the internet in november 1998 . and late last year , catex
offered users the ability to set up smaller networks , allowing them
form groups whose members do business only with one another .
since its inception , catex has completed about 450 trades ,
totaling $ 400 million in premium and more than $ 3 billion in limits ,
he said . catex ' s roughly 160 subscribers include reinsurers ,
insurers and corporate entities that purchase coverage through their
captives , mr . sweeney said .
" we obviously have a long way to go , but we are pretty satisfied
with what we have achieved so far , " mr . sweeney said .
the exchange sees increased activity after major losses , as cedents
seek to buy replacement coverage to offset depletions in their
existing cover , he said . for example , mr . sweeney said , there was
a flurry of activity after the european windstorms in december last
year .
last september , the chicago mercantile exchange entered the field
of insurance - related derivatives when it began offering weather
derivatives .
thus far , 420 futures contracts have been traded , said larry
grannan , senior director in product marketing at the cme .
such contracts are designed to allow businesses to hedge against
weather - related losses . for example , a utility may sell less power in
a mild winter , and it would be able to use the futures to hedge a
resultant fall in revenues .
the exchange first offered heat - based indexes for atlanta , chicago ,
cincinnati and new york . in january , it added philadelphia , dallas ,
des moines , las vegas , tucson and portland , and it began offering
contracts based on cold weather .
currently , most of the trades are between securities dealers
themselves , but , eventually , the contracts will likely be used more
extensively by utilities and insurers , mr . grannan said .
in addition , the futures contracts could be used as hedges for
over - the - counter securitized deals , he said .
copyright , 2000 dow jones & company , inc . all rights reserved .