HuRLOs relaunch for the 2009 hurricane season; provide new hedging platform

by Artemis on August 4, 2009

Today saw the relaunch of the much anticipated Hurricane Risk Landfall Options (HuRLOTM) from Weather Risk Solutions, LLC. We wrote about HuRLOs when they launched as a pilot back in October 2008 with much anticipation of the full launch as they offer an easily accessible method to hedge against landfalling hurricanes.

Trading opens today on these products with clearing handled by the CME Clearing division. They are designed to allow investors or businesses to hedge against the financial risk of hurricanes. Structured as call options on whether or where a landfalling hurricane may hit the U.S. Atlantic or Gulf coasts, they trade on an internet based platform run by Weather Risk Solutions.

An interesting difference between HuRLOs and other hurricane financial contracts is that they require no counterparty. Premiums are paid at the time of trading, then aggregated by the CME Clearing House into mutualized pools of risk. Come settlement time, those who hold HuRLOs for the location of a hurricanes landfall (or ‘No Landfall’ at the end of the season) receive a pro rata share of the pool (all other HuRLOs expire worthless at settlement). Prices are based on a combination of market movements and an index of historical weather risk data supplemented by real time data on hurricanes in motion.

HuRLOs are not designed to be an insurance replacement. Rather we’d see them as an instrument that could complement insurance coverage for businesses, fill the gaps in an insurance companies reinsurance policy or top up coverage in over exposed areas. They can also provide a method for anyone brave enough to bet on the outcome of hurricanes to play the market as an investment opportunity.

Contracts can be purchased which correspond to a hurricane making landfall in a specified coastal county or region, should a hurricane hit a county or region where you have purchased a contract then you’ll be eligible for a payout. Particularly of note is the fact that the risk pool (made up of market participants funds) pays out, therefore making the market responsible for it’s own losses. Also novel is the fact that for every hurricane there is a ‘No Landfall HuRLO’ which can be bought and in essence is a bet that the hurricane won’t reach the coast. It’s a similar model to some prediction markets but with official clearing backing it has the potential to be a highly liquid marketplace.

At launch 79 different HuRLOs are available for trade in two option series. 78 make reference to a geographical location where a hurricane could make landfall with the 79th being the ‘no landfall’ HuRLO. Each series will correspond to a different landfall event and has it’s own pool. Weather Risk Solutions say ‘For example, if hurricane Danny were the first storm to make landfall on the U.S. coast this year, series 1 HuRLOs for the county or region where Danny made landfall would exercise automatically and the remaining HuRLOs in series 1 would expire worthless. If no other hurricanes made landfall on the U.S. coast this year, the series 2 No Landfall HuRLOs would exercise automatically at the end of the season and all other HuRLOs in series 2 would expire worthless.

It’ll be interesting to see how wide adoption of these new instruments becomes. There are many other ways to hedge your hurricane landfall risks, but this one seems a particularly easy to access method which removes some of the barriers to entry that currently put off potential market participants. It will also be interesting to see who in the world of institutional investment is brave enough to bet on them.

Read more about them on the Weather Risk Solutions website here.

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