Public and Private Insurance with Costly Transactions

We characterize how public insurance schemes are constrained by hidden financialtransactions. When non-exclusive private insurance entails increasing unit transaction costs,public transfers are only partly offset by hidden private transactions, and can influenceconsumption allocation. We show that efficient transfer schemes should take into account theimpact of insurance on unobservable effort and saving choices as well as the relative cost ofpublic and private insurance technologies. We provide suggestive evidence for the empiricalrelevance of these results by inspecting the cross-country relationship between availableindicators of insurance transaction costs and variation in public and private insurance....