WP-009: Louis-Gaëtan Giraudet and Sébastien Houde, "Double Moral Hazard and the Energy Efficiency Gap" (August 2014)
Many studies have analyzed possible explanations for the energy efficiency gap, but few have approached it from the standpoint of moral hazard. Moral hazard is an economics term that describes a situation where two parties to a contract each have incomplete information about the transaction and don't bear all the consequences if they deviate from the contract.
The paper investigates how moral hazard problems can cause sub-optimal investment in energy efficiency. It focuses on the case of home energy retrofits, where both the contractor and the homeowner can take hidden actions that will result in lower energy savings than originally expected. The contractor may install lower quality materials to save on costs, while the homeowner may increase energy consumption after the retrofit. Both actions are unobservable to the other party and would lower the amount of total energy saved due to the retrofit.
The study quantifies the size of the energy efficiency gap due to moral hazard in the U.S. Insulation market and examines whether minimum quality standards or energy-savings insurance can mitigate the impact of moral hazard. The results show that the potential benefits from undoing moral hazard are larger than the cost of quality audits. In particular, they find that minimum quality standards outperform energy-savings insurance.