We analyse efficient risk-sharing arrangements when the value from deviating is determined endogenously by another risk-sharing arrangement. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any coalition formed (joined) after deviations rely on a belief in future cooperation which we term “trust”. We treat the contracting conditions of original and deviation coalitions symmetrically and show that higher trust tightens incentive constraints since it facilitates the formation of deviating coalitions. As a consequence, although trust facilitates the initial formation of coalitions, the extent of risk sharing in successfully formed coalitions is declining in the extent of trust and efficient allocations might feature resource burning or utility burning: trust is indeed a double-edged sword.

This article quantitatively evaluates the trade-off between the provision of health-related social insurance and the incentives to maintain good health through costly investments. To do so, we construct and estimate a dynamic model of health investments and health insurance in which the cross-sectional health distribution evolves endogenously and is shaped by labour market and health insurance policies. A no wage discrimination law in the labour market limits the extent to which wages can depend on the health status of a worker, and a no prior conditions law outlaws higher insurance premia for individuals with worse health status. In the model, the static gains from better insurance against poor health induced by these policies are traded off against their adverse dynamic incentive effects on household efforts to lead a healthy life. In our quantitative analysis, we find that it is optimal to insure 80% of labour market-related income risk (70% if a no prior conditions law is also present). Providing full insurance is strongly suboptimal, however, since at high levels of consumption insurance, the negative dynamic incentive effects on health effort and thus the population health distribution in the long run start to dominate the short-run consumption insurance gains.