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13 March 2012updated 26 Sep 2015 8:16pm

Betting on climate change

A blue-sky proposal by an Asian investment bank raises questions of propriety.

By Alex Hern

It seems like this is the sort of thing that gets the finance industry a bad name:

A financial product could be constructed with payments linked to a sea-level index, and featuring some characteristics similar to a catastrophe bond or weather derivative…

Protection would come in the form of a higher payment to the policyholder if the sea level rises more quickly than expected and a lower or zero payment if the sea level rises less quickly. Some creativity would be needed to make such a product acceptable to both the policyholder and insurer, but it is quite feasible.

But quite apart from the questionable PR which would result from creating such a product, it probably wouldn’t work, as alphaville point out:

In terms of getting the technicals of the product down pat, well why not. But thinking about it – you (as the insurer) would be selling insurance on a potentially massive, truly systemic risk here. Something that could – over time – remove island nations from the map altogether. Not something you can hide from using the law of large numbers, quite possibly.

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The chart accompanying the original study shows that 37.2 million people in India alone are at risk from sea-level rises by 2050, and well over 100 million in Asia alone — as well as another 8 million in the USA. It is likely global catastrophe of that level isn’t something the world financial system could escape unscathed, so while the creator of these bonds would make a nice income in the years leading up to disaster — and an even nicer one if climate change was indeed averted — anyone expecting that the insurance they had purchased would actually protect them against anything would be in for a nasty surprise. Almost as nasty as the people living in coastal areas.