It sounds like you ordered the wrong appetizer at that weird new restaurant around the corner. But no...this has to do with finance.
We all like "simple," and insurers are no exception. Often, gauging loss and how to handle that loss involves an insurer and a reinsurer, and negotiations, and complicated estimates, and more intense negotations. You get the idea.
So, in 1992, the CBOT Chicago Board of Trade started trading these contracts after recognizing the need for insurers to protect themselves in a new way against loss. Prior to 1992, the insurance company pretty much had to try to keep enough in reserves to cover their best-guess loss total, or just shift the cost to the member. If you watch the news, you’ll know deductibles are still an issue in 2018, but we digress, Often, insurance companies just didn’t sell policies to people who lived in areas with a lot of natural disasters.
Futures contracts are an agreement to buy a security at a set rate at a specified time in the future. The spread here is the difference between the asking bid price and the selling price. Insurance companies report their losses and premiums quarterly. Those amounts form an index for that specific region.
It works like this: the insurer buys a catastrophic futures contract. The losses exceed the premiums, the loss/premium ratio works in their favor, and they make money. It makes it easier to absorb the losses. When they’re low, the insurer might actually lose money. The contracts are designed to cushion the blow in the event of bigger-than-expected losses. They are an insurance policy for the insurance company, if you will. And we're sure you will.
Related or Semi-related Video
Finance: What are the NASDAQ and NYSE?74 Views
Finance a la Shmoop. What are the NASDAQ and the NYSE? Nasdaq, yeah it stands for
National Association of Securities Dealers Automated Quotation-systems. And [NASDAQ defined]
yeah, it feels like they got cheated out of an S in there somewhere, like NASDAQ'S.
That's what happens when life's on a budget. So NASDAQ is an electronic
version of the original wall, as in Street, Wall Street, yah that. Where
well-dressed folks would come with cash in hand scream out a stock and a price [stock market in 1900s]
and then trade shares. They would trade for whatever was trending at the time. Like
eyeball massagers, or wooden swimsuits, or motorised surfboards, all real things
by the way. NASDAQ is the much more modern version of its predecessor NYSE.
Is anything but nice when you lose money there. NYSE stands for New York
Stock Exchange and it too was an outgrowth of the well-dressed folks at
the wall. There are two key structural differences in the two trading systems,
the NYSE is an actual physical place, has a physical location, address, etc. and this [NYSE Building]
is what it looks like. NASDAQ is really a concept, a religion, a
network, it's not really a place. At least not a geographic place. The other big
difference is the manner in which shares are traded. The NYSE is an auction-based
system, one individual is a buyer of AMZN at $983.25, he screams electronically
that number and then buys from whoever is willing to sell at that price.
Individuals buy from individuals. That's an auction market. But NASDAQ is a
dealer market, that is somebody deals in the stock. They go out into the market[online stock market]
and buy say a million shares of whatever.com that was bought in the market
conveniently for exactly ten bucks even. That dealer now makes a market in that
stock, ie the dealer is kind of you know, their own individual market. And she
moves with the market to manage the spread in the trades. Like she might have
a narrow spread, where she's a buyer of the stock at $10.02 and a seller of the
stock at $10.07 a share. Or it's a really wild volatile stock, on a wild and [man and woman on rollercoaster]
volatile day, she might be a buyer only at $9.90 and a seller at $10.30, making 40
cents a share trade. Well you could do the fancy math that if she
keeps her inventory steady at a million shares and trades a million shares that
day. Well with that spread she makes 40 cents times a million or 400 grand for
the day's efforts. However after staring at a screen all day she's gonna have to
spend at least some of that money on eye care. [woman in office]
Thank goodness for those eyeball massagers.
Up Next
What's the SEC? Easy. Seals Eating Candy. Or maybe Silly Elephants Canoodling? We can never remember. Guess it's time to watch this video and refre...
NYMEX, or the New York Mercantile Exchange, is an exchange where commodities are regularly traded.