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.