Formal Insurance and Informal Risk Sharing Dynamics: The Role of Social Preferences

Abstract

The literature has mixed results on how formal insurance affects informal risk sharing. Whether such effect is motivated extrinsically or intrinsically also remains unclear. We design a lab experiment in which formal insurance is introduced and removed unexpected and the insurance purchase decisions are either voluntary or forced. We find, quite surprisingly, that informal risk sharing is significantly improved after the removal of formal insurance, primarily for subjects making asymmetric insurance take-up decisions voluntarily. Investigating the dynamics suggests that it is those who take the insurance acting first to share more risk for their partners. We propose a model based on a particular feature of social preferences, guilt aversion, to explain our findings.

Keywords: insurance, risk sharing, crowding-out, social preferences, guilt

JEL Classification: C91, D81, O17