The evolution of the CME Hurricane Index (CHI) resulted from what Steve Smith of TigerRisk Partners calls “the perfect storm.” In addition to being involved in trade of the products now, Smith took the lead on developing the Index when he was president of ReAdvisory Property Solutions at Carvill America.
In 2004 and 2005, after an unprecedented series of hurricane losses were seen for the reinsurance and insurance industries, the industry was looking for alternative sources of capital, Smith notes.
The reigning scale before the creation of this index was the Saffir-Simpson Hurricane Scale, which is used by National Oceanic and Atmospheric Administration hurricane forecasters, and assigns storms to five categories. This scale can be used to give an estimate of the potential property damage and flooding expected along the coast with a hurricane. “I was searching for a better, more scientific, way to describe hurricanes,” says Smith. “Calling something a ‘large cat four’ didn’t strike me as being the best way. What does ‘large’ mean in that context?”
Hurricane Katrina had a CHI value of 19 when it made landfall.
And since the CHI is based on the physical parameters of the storm it “generates a final value for the storm very quickly, unlike other measures which use insurance claims data. Insurance claims data-based products have their places but are not well liked by hedge funds etc. since they can take upwards of 24 months to generate a final value,” he says.
According to Smith, the fast settlement of the CHI allows the reinsurance and insurance industry to tap new sources of capital since it removes the need to wait 24 months before settling. In 2009, CME Group acquired the Carvill Hurricane Index from Carvill America Inc. and renamed it the CME Hurricane Index. CME’s hurricane futures and options are settled to the CME Hurricane Index (CHI), which provides a numerical measure of the destructive potential of a hurricane. The CHI is based on the calculation of the maximum wind velocity and size (radius) of each official storm to calculate the potential for physical and financial damage. The higher the CHI number, the more potentially damaging the hurricane.