News You Can Use: "The Economics of Kidnap Insurance"

From the Conversable Economist:

There is reason to be dubious, at least in theory, about  how kidnap insurance can work. After all, buying kidnap insurance only makes sense if you believe that, in the case of being kidnapped, it will increase your chance of being released. After all, if kidnappers know (or can figure out) that certain people have kidnap insurance, won't they tend to target such people? Also, if a kidnap victim has insurance  has insurance, won't the kidnappers demand the monetary equivalent of the earth, moon, and stars as a ransom? In these ways, might the presence of kidnap insurance increase the amount of kidnapping? On the other side, insurance companies have a profit motive to take actions that would reduce the number of kidnappings and the size of ransom payments. But if kidnappers make extraordinarily high demands and the insurance company pushes back, then it seems likely that negotiations over ransom will tend to break down--in which case the rationale for buying kidnap insurance in the first place would disappear. And how can kidnap insurance companies figure out a way to deal with the situation of kidnap victims who don't have insurance: if the representatives of those victims (who may in some cases be national governments) pay high ransoms, then it will be harder for the companies that sell kidnap insurance to keep other ransom demands down.

 Anja Shortland explores "Governing kidnap for ransom: Lloyd's as a `private regime," in an article forthcoming in Governance magazine (the publisher, Wiley, has laudably made an "Early View" preprint version of the article available here). The short answer to the concerns over how kidnap insurance markets are likely to break down is that if all the companies providing that interact with each other, swap information, and follow common protocols, then kidnap insurance can function. For kidnap insurance, Lloyd's serves as a place where that interaction happens. Shortland writes (citations omitted):

Kidnapping is a major (if largely hidden) criminal market, with an estimated total turnover of up to US$1.5 billion a year. Transnational kidnaps, where the victims are foreign tourists, high-net-worth local residents insured by multinational insurers, and the employees of foreign enterprises, are scary one-off events for almost all families and most firms. Ransoming hostages is beset with trust and enforcement problems. Kidnappers seek to maximize ransoms and can employ extreme violence to pressurize stakeholders to reveal their assets. Law enforcement may prepare rescue operations while families (pretend to) negotiate a ransom. Any sequential payment process is potentially problematic, but ransom drops can fail even if both parties act in good faith. Kidnappers need not release (live) hostages after payment and may demand multiple ransoms. Yet, despite these considerable difficulties—and contrary to general perceptions based on newspaper headlines—the vast majority of transnational kidnap victims survive and most cases conclude relatively quickly.  ...

Commercially, kidnap insurance is only viable under three (related) conditions. First, kidnaps should be nonviolent and detentions short—otherwise, individuals and firms withdraw from high-risk areas. Second, insurance premia must be affordable. Although insurance is only demanded if people are concerned about kidnapping, actual kidnaps must be rare, and ransoms affordable. Insurers struggle in kidnapping hotspots: High premia deter potential customers. ... Third, ransoms and kidnap volumes must be predictable and premium income must cover (expected) losses. If kidnapping generates supernormal profits, more criminals enter the kidnap business. Premium ransoms quickly generate kidnapping booms. Insurers, therefore, have a common interest in ordering transactions and preventing ransom inflation. ...

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