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Catastrophe Futures

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Definition of 'Catastrophe Futures'

Insurance Catastrophe Futures Contracts began trading on 11 December 1992 on the Chicago Board of Trade (CBOT).

In traditional insurance or reinsurance, the process of insuring against catastrophes is tedious requiring months of negotiations to conclude a sound agreement, In addition, the reversal of such agreements through commutation negotiations is equally tedious. Through the design of uniform insurance agreements, the CBOT attempts to develop a liquid market in which catastrophe risks can be easily assumed or transferred and in which non-traditional capital is attracted to insurance.

The value of a catastrophe futures contract is equal to $25,000 multiplied by the catastrophe ratio for the quarter. The catastrophe ratio is a numerical value provided by the CBOT every quarter.

The value of a catastrophe futures contract increases when catastrophe losses are high and decrease when catastrophe losses are low. In the event of a catastrophe, if losses are high, the value of the contract goes up and the insurer makes a gain that will partially offset losses that might be incurred. The reverse is also true. If catastrophe losses are lower than expected, the value of the contract decreases and the insurer (who is normally the buyer of the contract) loses money.

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