If you think you are going to be kidnapped and you purchase ransom insurance, no one can know. Then, if it happens, you need someone who can transport large amounts of cash across national borders.
You could be a U.S. executive in a nation with political turmoil. Or your cargo ship could have to cross pirate-occupied territory. Both have higher odds for a kidnapping and a ransom demand. During negotiations, the goal is cooperation and stable ransom amounts. When kidnappers believe that a maximum has been achieved, they will release the hostage.
In Captain Phillips, we saw Somali pirates overtake Tom Hanks’s cargo ship:
The subsequent negotiations would not have been random.
The Supply Side
Kidnapping is a relatively regular event. Because the same groups of people do it, they exhibit somewhat predictable supply-side behavior. To get their money each time, they have to return the individual. Then, the next event unfolds somewhat similarly. The hostage “return rate” is actually 97.5%.
The Demand Side
Companies that operate through Lloyd’s of London are the sole source of hostage insurance. From the insurer’s perspective, the goal is a profitable product. That means diminishing its use. You can see why. When someone knows about the potential to pay, the odds of a kidnapping rise as does the amount so the contract has to be a secret. It’s all though just demand-side behavior. They want to minimize the equilibrium price.
In between, we have the people who negotiate the equilibrium price. They know that the kidnappers will display typical supply side behavior by trying to optimize the ransom. Correspondingly, the victims want to get their “purchase” done at the most reasonable price. The final, not to be ignored challenge is paying. Typically you need unmarked small denomination notes. They need to wind up in the right place without harming the provider or the recipient.
All of this works most of the time because of the market’s incentives.
Our Bottom Line: Moral Hazard
While many economic ideas relate to ransom markets, let’s just look at moral hazard. Moral hazard is defined as a response that encourages more of the same behavior. It involves situations that range from “too big to fail” to kidnapping. With “too big to fail,” the moral hazard is the rescue. If a bank knows that a government will save it, the behavior continues.
Similarly, with kidnapping, insurance creates moral hazard. Because it encourages what it wants to avoid, no one is allowed to know that it exists.
My sources and more: Somewhat obscure and heavily market tilted, The Economics Detective podcast can be a handy source of key economic ideas for quirky topics. But, if you prefer a shorter discussion of ransom markets, do go to Marketplace.org. All though was based on Anja Shortland’s research at King’s College and her book, Kidnap: Inside the Ransom Business.