An insurance contract with a low compensation period under adverse selection

- We design an insurance contract with a low compensation period and subsidies.
- The low compensation period can help distinguish the risk types of individuals.
- Our contract weakly dominates the traditional partial insurance contract.
- When it comes to the separating equilibrium, the low-risk policyholders can obtain higher utility from our contract.

Adverse selection has a significant influence on trading efficiency in insurance markets. Inspired by the quality identification function of the probation period in the secondhand car market, an insurance contract with a low compensation period is designed. It is proved that the contract can distinguish the risk types of the policyholders to achieve a separating equilibrium. And it can make a strict Pareto improvement to the traditional partial insurance contract under certain conditions. Finally, an example is given to demonstrate the conclusions.