Catastrophe bondsOne way of investing directly in catastrophe risk is to trade cat bonds. These are debt instruments in which the issuer's obligation to pay interest or repay the principal is deferred or forgiven in the event of the catastrophe occurring
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In our case, we could issue a cat bond that triggers in the event of < 1m sq km of sea ice extent. (That's called a parametric trigger, and it's what we want because it's not linked to an actual loss.) The sooner the Arctic goes ice-free then the more money we make. After a certain time we start to lose money, and unless we've hedged then our losses could continue until all our capital is gone.
Who would buy such a thing? Speculators. Investors who think our risk analysis is wrong. Insurance companies, since we're effectively requesting to be insured against the event happening, but by way of a security instead of an insurance policy.
A typical cat bond has three parties: a sponsor (in this case us), an investor who provides the capital, and a special purpose vehicle (SPV) that holds the collateral on behalf of the investor and shelters the capital should the sponsor go broke. We'd have to have substantial capital to be taken seriously enough for anyone to buy them from us.
A bond is most profitably issued by a creditworthy entity. The composition of sponsors in the cat bond markets is approximately: 60% primary insurance companies, 25% reinsurance companies, 10% government entities, and 5% large corporates. Why would anyone trust us to continue paying interest? They don't really need to. The risk of us defaulting would be priced into the yield of the bond. If we default then they get their money back.
A more practical alternative might be to short sell existing bonds. The principle is the same as shorting any other security. You own less than (i.e. are short of) what you promise to sell in the future. So you might contract with someone to sell them $1m of cat bonds at todays price in a year. The catastrophe becomes more likely so the price falls, or the cat happens and the bonds are worth nothing. Or nothing happens and you have to go trade some bonds, potentially at a loss.
The difficulty is finding suitable bonds to short. No one has ever offered sea-ice bonds as far as I can see, unless it has happened in private. An ice-free Arctic certainly seems like an insurable event, since it could adversely affect markets, so it's possible that happened.
For our purposes, sea-level rise could be a usable proxy, since sea-level rise is coupled to sea-ice melt, not in the sense of one leading to the other, obviously, but in the sense of both being caused by warming. Thus we can bet on sea-ice indirectly by betting on sea-levels. And sea-level risk is unambiguously real, and thus insurable. But I can't find any sea-level bonds either. I suspect this is because catastrophe bonds typically offer protection over a three-year period. No one offers cat bonds over the long time periods needed for sea-level rise to trigger loss-related bonds' defining events.
Obviously, sea-level risk is abstracted from sea-ice risk by time as well as by Archimedes' principle. What we'd be betting on is that the conditions that caused an early melt of the Arctic would then lead to an early melt of land ice and thus faster sea-level rises than models predict. But this would take time to play out.
1www.jana.com.au/wp-content/uploads/2012/04/Capital-Markets-Jan-20121.pdf[Edit: cat bonds are intended as insurance against real-world events such as hurricanes. The kind of speculation we're engaging in here might be considered immoral, like speculation in sub-prime in the run-up to the GFC might have been, but I have nothing to say about that. It's a choice for investors to make.]
