What Does Insurance Derivative Mean?

Insurance derivatives are used by those insurance companies who intend to ensure they are protected against catastrophes and losses that result from rare and unforeseen events, an earthquake or a tornado for instance.

This financial device usually has two defining features. One is related to a so called ‘insurance-index’ which shows when and how well the insurance company is protected, while the other refers to the types of events for which the insurance is valid.

Insurance Derivative Explained

The best way to understand how insurance derivatives work is through comparing them with derivatives on the financial market. The latter version has marketable securities as its point of reference, while insurance derivatives are connected to a careful and very detailed statistics based on fixed insurance-related events. The value of this derivative type is more difficult to be followed in the usual way compared to financial derivatives which have the stock exchange where anybody can get information about an index’s performance.

An insurance derivative usually implies financial compensation to its owner in case losses related to a tornado for instance are at the target line. This can be analyzed by special indexes used by these financial instruments.