Informal Insurance, Enforcement Constraints and Group Formation

Describing group formation in the context of informal insurance schemes with enforcement constraints, the paper states that stable groups are always bound in size (no matter what the size of the ambient community is), and that an increase in environmental risks can lower the overall provision of insurance. After an extensive literature review on groups in risk-sharing and risk-sharing agreements, it says smaller groups may threaten the stability of a large group as subgroups can deviate from insurance arrangements created by larger groups. The paper formulates a recursive definition of group stability and applies it to the insurance problem. It shows by means of some general analysis and several examples, how this affects the predictions of the standard insurance model. Specifically, the paper:

• Examines group formation under equal sharing and stationary transfers;
• Explains why risk-sharing agreements will generally make use of history dependence and of asymmetric strategies in subgames;
• Endogenises both group formation and risk-sharing agreements.

Also, it illustrates group formation by means of the simplest possible model and extends the model to allow for the recognition (by a group) that it may be constantly under threat from potential deviants.