Academic journal article Economic Inquiry

Altruism, Matching, and Nonmarket Insurance

Academic journal article Economic Inquiry

Altruism, Matching, and Nonmarket Insurance

Article excerpt

I. INTRODUCTION

Nonmarket transactions are commonplace, even in situations in which market substitutes are available. The provision of insurance is one such case in which both market and nonmarket products coexist. Spousal support and income pooling, bequests and other income transfers designed to smooth consumption across generations, government social welfare schemes, and financial support from family and friends are all cases in which individuals or groups provide nonmarket coinsurance. The decision to enter into nonmarket insurance agreements, while individually rational, may affect equilibrium market insurance contracts such that overall welfare fails.

In many nonmarket situations, altruism plays an important role both in motivating the structure of the nonmarket arrangement - who insures whom - and in influencing the results of that arrangement.(1) This paper examines coinsurance arrangements between altruistically linked agents and highlights the role of altruism in creating the incentive to coinsure and the benefits from coinsurance. We focus on the effects of altruistically motivated nonmarket transfer on the market provision of insurance and on the welfare effects of this market-nonmarket interaction.

The provision of private insurance affects not only the individual participants but also equilibrium in the insurance market through the aggregate effects of nonmarket arrangements. One aim of this paper is to highlight the market-non-market interaction within the literature on altruism. Existing work on altruism and income transfers examines these nonmarket institutions taking the structure of the market as given. However, while a single pair of individuals correctly regard themselves as price-takers in the insurance market, the aggregate effect of nonmarket transfers does influence the market payout/premium ratio. We demonstrate that, through its effect on effort, nonmarket insurance lowers the market payout for a given insurance premium if the degree of altruism is sufficiently low. As partners care more about one another, nonmarket transfers increase the insurance payout; this positive externality on the market is socially beneficial.

Our model is one in which the insurance market cannot observe the care an individual takes to avoid an accident and, as a result of the moral hazard between the market insurer and the insured, individuals can obtain only incomplete insurance. Incomplete insurance creates an incentive for individuals to obtain additional insurance, and hence agents are willing to enter into coinsurance arrangements.

In the case in which coinsurance partners cannot observe the level of care one another take to avoid an accident, there is a second moral hazard problem, between the partners. Arnott and Stiglitz [1991] show that nonmarket insurance serves only to crowd out market insurance. Individuals view themselves as price-takers in the insurance market, but the aggregate effect of many such individuals is to decrease the amount of market insurance offered and shift risk from risk-neutral insurers to risk-averse individuals. In the absence of altruism, nonmarket insurance is unambiguously welfare decreasing.

Allowing individuals to choose coinsurance partners with whom there is mutual altruism has several important consequences. First, individuals prefer to pair with partners with whom there is mutual altruism (Proposition 1). That altruism plays a role in matching coinsurers is not surprising in light of the nature of non-market insurance. All the examples above, from spousal support to welfare schemes, involve a degree of altruism among the participants.(2) While altruism does not provide the sole motivation for nonmarket insurance - even non-linked agents are constrained in the amount of insurance they can purchase and thus are better off by coinsuring - altruism motivates the choice of partner and increases the effort partners take to avoid an accident. …

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