Can index-based weather insurance enhance the sustainability of renewable electricity systems? A game-theoretic analysis

The intermittency of renewable energy (RE) poses a dual risk to electricity system reliability and supply chain financial stability, challenging the efficacy of environmental policies like the Renewable Portfolio Standard (RPS). Existing research lacks a theoretical analysis of how financial instruments and environmental policies interact to manage this operational risk. To fill this gap, we develop a Stackelberg game-theoretic model comprising a generator, a retailer, and an insurer, to analyze how Index-Based Weather Insurance (IBWI) can serve as a risk-decision tool to mitigate supply uncertainty and enhance system resilience. Our findings are threefold: (1) Appropriately priced IBWI significantly enhances system sustainability and reliability by incentivizing RE procurement, creating a win-win-win equilibrium for all stakeholders. (2) We uncover a “policy paradox”: in the presence of IBWI, increasing RPS quotas can counterintuitively decrease renewable electricity orders and harm generator-retailer profits. (3) The effectiveness of IBWI and the resulting equilibrium are critically sensitive to the premium rate, requiring a delicate cross-agent trade-off between risk, cost, and incentives. This research provides a novel theoretical framework for integrating financial instruments into the reliability and risk management of energy systems, offering crucial decision-making support for designing integrated policies that are both cost-effective and resilient.