New way for individuals to invest in hurricane risk

Sep 5, 2006 @ 12:01 am

By Gary S. Mogel

NEW YORK - Weather-related investing, now dominated by hedge funds, has been made available to the masses.

HedgeStreet Inc. of San Mateo, Calif., announced in August the opening of its online retail market for trading Atlantic Ocean hurricane contracts. The contracts give investors - including those who do not have the $1 million or more minimum investment required by many hedge funds - the ability to speculate on the economic effect of hurricane and tropical storm damage.

"We are offering a low-cost means of investing in risk from hurricane and tropical storm damage," said Bill McIntosh, vice president of marketing for HedgeStreet. "The goal is to open up a market for smaller investors who previously had a hard time accessing it."

Currently, the system is open to individual investors but not their advisers. However, an "intermediated marketplace" - in which financial advisers could trade hurricane risk on behalf of clients - soon may be developed, according to Mr. McIntosh. One issue is what special licenses, if any, advisers would have to acquire.

The contracts also can be used by insurance and reinsurance companies to hedge their storm-related risks.

"Advisers I have spoken to say they can use the system to hedge client risk exposures in parts of the portfolio they don't control," Mr. McIntosh added. Small- and medium-sized hedge funds also have shown an interest," he said.

Here is how the system works, according to Mr. McIntosh, using the recent storm Ernesto as an example:

"In one type of the $100 binary contracts, investors can speculate on whether there will be more or less than $25 million in insured damage from Ernesto," he said. "Investors who think there will be more are buyers; those that think there will be less become sellers."

"The asking price for the buyers is currently $41 [as of this writing]. That means that about 41% of people think that damage will exceed $25 million, and they would get $100 for that $41 investment if they are correct. So investors can conceivably get started with only $41 and sometimes less, although most trade more than one contract."

There also are $100 binary contracts in which investors can speculate on the storm exceeding $1 billion in damage, and the asking price on those was $15.

"New traders are usually buyers first, until they become familiar with short selling," Mr. McIntosh said.

The system uses projected insured loss data from the Insurance Services Office Inc. in Jersey City, N.J. Those preliminary estimates from ISO - not the actual insured damage that may take months or even years to sort out - are used to settle the contracts.

The contracts "enable the risk transfer of insurable losses within the insurance industry and will help link reinsurance markets with traditional capital markets," said Gary Kerney, assistant vice president of ISO's property claim services unit.

Trading closes a day before the ISO estimate is scheduled to be announced. Contracts don't have to be held until trading closes - they can be bought and sold anytime before the close, according to Mr. McIntosh.

There is a 1% trading fee, so investors would be charged $1 for every $100 contract traded.

Less exposure to unexpected

Although some investors become relatively active traders, Mr. McIntosh indicated that it has not reached the point where it is comparable to day traders making short-term investments in stocks. Active traders may trade about five to 15 contracts a day, he noted. Because the hurricane contracts have definite upsides and downsides, there is less exposure to large unexpected gains and losses.

New members are eligible for 30 days of free trading, and real-time funding allows investors to begin trading immediately after opening an account. The last trading day for the contracts coincides with the last day of the hurricane season, Nov. 30.


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