“Catastrophe swaps” – aka “weather derivatives” – are an obscure derivatives “Frankenstein” created under the auspices of helping property & casualty insurers and re-insurers to “transfer” a portion of the risk on a portfolio of catastrophe insurance to the “marketplace.”
In reality, it was just another Wall Street mechanism designed to generate huge fees for Wall Street derivatives bankers. Without a doubt, just like financial market OTC derivatives and “portfolio insurance,” these derivatives were significantly underpriced relative to the true statistical expected value of the contract. After all, if the cost of weather catastrophe protection carries a high premium, it wouldn’t generate much sales volume and thus wouldn’t generate fees for Wall Street.
Florida has addressed the problem of the cost of hurricane insurance by creating a State run insurance fund – the Citizens Property Insurance Corporation – to provide hurricane insurance to those who could not otherwise afford to pay the premiums in the private insurance marketplace. Notwithstanding the fact that anything like this run by any government will eventually lead to undesirable results, that fact that cost of hurricane risk insurance had to be socialized in Florida reflects the fact that the expected value of the cost of insuring against hurricane damage is higher than most households can afford.
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