With the Atlantic hurricane season getting underway this week, rising temperatures and wind speeds on the Eastern Seaboard and Gulf Coast could give way to rising trade volumes for the Chicago-based CME Group Inc. for hurricane derivatives.

Last year 32,600 contracts were cleared through the CME, most of which were traded during the hurricane season. So far this year 4,000 contracts were traded in January and more are expected to be exchanged as the hurricane season progresses.

At the present, hurricane derivatives are a small player in the market, said Bill Bergman, an insurance industry analyst with Morningstar Inc., adding that there is potential for the contracts to become more popular.

“It’s an exciting product that could fill a very substantial niche down the road,” he said.

Born in the wake of the destructive hurricane season of 2005, the contracts were conceived as a solution to some of the problems arising from hurricanes, namely, the time it takes for insurance claims to be paid after one occurs, said Steve Smith, senior vice president at Willis Re, the reinsurance arm of global insurance broker Willis Holdings Group Ltd. That delay could prove to be detrimental to a company, which needs the money to resume normal operations.

“If I’m running a business, I may have to pay for repairs out of pocket and it may take upwards of a year before I get insurance money,” said Felix Carabello, director of alternative investments at CME.

Delays occur because insurance and reinsurance companies take time to assess losses caused by a storm. That led Smith to find a way to peg the payout for a hurricane not to damage it causes but to its strength and destructive potential.

“They were looking for an index that captures hurricane risk but at the same time you don’t have to wait 24 months,” he said.

However, Smith, while working at Carvill America Inc., found that classifying a hurricane using the metric commonly cited by the media, the Saffir-Simpson Scale, which rates a storm’s strength on a scale of one to five, failed to provide an accurate measure of a hurricane’s potential for damage.

Utilizing research done at the University of Colorado, Smith created the Carvill Hurricane Index, now called the CME Hurricane Index after CME purchased it in April. The CHI calculates the potential for damage from a storm by using National Weather Service data regarding the wind speed and radius of a hurricane.

The index more accurately assessed the strength of Hurricane Katrina than did the Saffir-Simpson Scale. For example, the Saffir-Simpson Scale rated Hurricane Wilma stronger than Hurricane Katrina, whereas the index more accurately captured that Katrina was a potentially more destructive storm.

Armed with that accuracy, it was then possible to incorporate storms into a tradable hurricane futures contract. CME began clearing the contracts, which allow a company to hedge against the risk posed by either an individual hurricane or an entire season.

If a company decides it needs additional coverage in the event of a storm or, in the case of an insurance company, wants to offset some of the risk of holding several insurance contracts in areas susceptible to hurricanes, it can find a party willing to enter into a hurricane contract. The company looking to offset its risk will decide how strong of a storm on the CME Hurricane Index it could withstand and then seek a contract that would pay out the desired amount of coverage if the hurricane was stronger than that when it made landfall.

For a company to receive $10 million of coverage on a CHI 15 storm in Florida, currently that company would have to pay 15 percent to 17 percent or $1.5 million to $1.7 million, according to Steve Breen, executive vice president at Tradition Re LLC, which brokers hurricane contracts.

If the storm makes landfall and is a15 on the CME Hurricane Index, the company that bought the coverage will receive the $10 million in two days instead of the two years it make take for insurance companies to pay. If the storm makes landfall below a15, the company is out the premium it paid.

While the primary users of hurricane contracts are reinsurance companies and hedge funds, the derivatives could gain a foothold in other industries susceptible to large-scale impact from hurricanes.

“Where I think this has real legs is the oil and energy and gas markets, once they see liquidity and volume this will be a brilliant way to hedge risk,” said Breen said.

Big storms could mean big losses for companies with refineries or oil platforms in the Gulf Coast region. While traditional insurance could help cover the damage incurred to a refinery or offshore oil platform, a hurricane derivative could be purchased to also cover money lost because of a decline in production if a large storm hits.

At the present, hurricane derivatives are a small player in the market right now, Bill Bergman, an insurance industry analyst with Morningstar Inc. said there is potential for the contracts to become more popular.

“It’s an exciting product that could fill a very substantial niche down the road,” said Bergman.