CDF-based Reliability Insurance Contracts Considering Free-riding

As a result of many disadvantages faced by the regulator in current regulatory schemes, reliability insurance scheme (RIS) has been introduced as a new regulatory scheme. This scheme allows consumers to determine their coverage levels according to their value for reliability services (i.e., cost incurred for outages), and pay corresponding premiums to the utility. The utility is then required to reimburse consumers for outages according to their outage cost. The consumer's outage cost is extremely dependent on the duration of outages and this dependency is well defined by a function known as a Customer Damage Function (CDF). To enable consumers to fully cover the reliability risks, utility should provide consumers with contracts which allow them to select coverage levels according to their CDF. Due to the inflexibility of electrical grids, most utilities cannot differentiate the reliability services at the household level and so the public good aspects of the reliability services are emphasized. In such circumstances, selfish consumers can misrepresent their willingness to pay for the reliability services and benefit from their neighbors' choices (i.e. free-ride on the reliable services provided for their neighbors). Free-riding may lead to the underinvestment in the grid. In this paper, primarily, CDF-based insurance contracts are designed and in following, a method for solving the free-riding problem is presented. (C) 2013 Elsevier Ltd. All rights reserved.