Optimal contracts under adverse selection for staple goods such as energy: Effectiveness of in-kind insurance

An income loss can have a negative impact on households, forcing them to reduce their consumption of some staple goods, such as energy. This can lead to health issues and, consequently, generate significant costs for society. We suggest that consumers can, to prevent these negative consequences, buy insurance to secure sufficient consumption of a staple good if they lose part of their income. This paper’s contribution is twofold. From the theoretical side, we develop a two-period/two-good principal–agent problem with adverse selection and endogenous reservation utility to model insurance with in-kind benefits. This model allows us to obtain semi-explicit solutions for the optimal insurance contract. Secondly, using recent aggregate statistics on households and their energy consumption, our model is applied to the context of fuel poverty. For this application, we can conclude that, even in the least efficient scenario from the households point of view, i.e., when the insurance is provided by a monopoly, this mechanism decreases significantly the risk of fuel poverty of households by ensuring them a sufficient consumption of energy. The effectiveness of in-kind insurance is highlighted through a comparison with income insurance, but our results nevertheless underline the need to regulate such insurance market.