highlighted by representatives of the Chicago Board of Trade and Centre Financial Products at a presentation last week.

Ms Dena Kotsores-Karras, a product manager, and Ms Sylvie Bouriaux, an advisory economist, at the Chicago Board of Trade (CBOT) and Mr. Joseph Coles of Centre Financial Products were invited by the Bermuda Insurance Institute to speak on catastrophe insurance contracts, hedging applications, and options pricing.

The Board of Trade has made similar presentations during the year. Last week, prior to the Bermuda speech, presentations were made in New York and Chicago.

The contracts described are applicable to Bermuda-based property insurers and reinsurers if they underwriting or reinsuring US property exposures.

"These firms could use the contracts to manage the catastrophic type of risk they are writing,'' said Ms Kotsores-Karras.

She said the new property catastrophe companies she had spoken to since last week presentation were "intrigued'' by the concepts.

So far, the contracts are used by large reinsurers and speculators. Ms.

Kotsores-Karras named two justifications for the futures and options markets: price discovery and risk transfer, alternatively known as hedging.

Firstly, she defined price discovery as price information that is used as a benchmark in determining the value of a particular commodity or financial instrument.

"In the same way, trades are made and prices are determined by buyers and sellers on the trading floor, and it is this price information that serves as a benchmark value of a particular commodity. As far as catastrophe futures are concerned, we have a benchmark quarterly loss ratio for the US property market,'' she said.

"We also trade call option spreads, or, in insurance industry terms, layers of reinsurance. The market currently determines the benchmark value for various standardised layers of reinsurance.

"The user will have to understand the nuances of the contracts and understand pricing, but they can see what the quarterly loss ratio for the US and the eastern and midwestern regions of the US are, using any vendor which quotes trading markets.

"The second justification of our market is risk transfer or hedging. "Firms who seek to transfer a risk that they have; be it a price risk, or an interest rate, or in the case of insurance, a risk of a catastrophic event occurring, can transfer this risk to someone who is willing to accept this risk.

"That would be a speculator in the marketplace. The speculator accepts that risk with the hope of making a profit.

She described the risk transfer mechanism through the purchase or the sale of a futures, or option contract, which are standardised agreements to buy or sell a commodity, or in the case of catastrophe futures, buying or selling a loss ratio or for options, a layer of reinsurance or a call option spread.

"A futures contract is standardised and the only variable is price and that is what is determined on the trading floor. This differs from reinsurance because the terms are negotiated.

"The cat contract is designed to manage increasing claims arising from unusual catastrophic losses. We have four catastrophe futures contracts: a national one, which tracks all losses in US, and three regional ones, Eastern, Mid-West and Western.

"Futures contracts have to be based on cash markets. Because there is no underlying market for us to base this catastrophe contract on, there is no loss information, we went to ISO, a statistical agency, that gathers loss data from firms that contribute to it.

"ISO provides statistical and actuarial information back to the insurance industry. ISO will be the pool manager for this contract. It will take losses and premium data and weigh it by a certain factor and form more representative regional pools and form an industry standard.

"Because of the limited risk/reward profile of a call option spread, CBOT has seen most of its activity in the call spreads. A 1,000 lot order transaction recently occurred in the options markets,'' she said.

"Perils covered include wind, hail, earthquake, riot and flood.

"The catastrophe contract trades on a quarterly cycle. For example, the March contract tracks first quarter losses. First quarter losses must be reported between January and June. These six months would capture enough of the loss, that occurred during the prior quarter.

"If losses are not reported by June they will not be included in the March contract. The final settlement date will be in October.

She said another important benefit in trading these markets is the daily cash flow. Every day gains and losses are recognised and profit/losses will be reflected in the trading account. You know exactly what your position is each day, said Ms Kotsores-Karras.

The Chicago Board of Trade primarily trades financial products. A non-profit organisation, the board is organised and owned by the members of the Exchange.