Analysing the market in kidnappings

Fascinating article by Anja Shortland that seeks to explain the motivations and dynamics of the market in kidnappings, 

The first principle that insurers adopt is that safe retrieval of hostages is paramount. The second guiding principle is that kidnapping cannot become too wildly profitable, for fear of further destabilization. In the language of economists, there must be no “supernormal profits.” If victims’ representatives quickly offer large ransoms, this information spreads like wildfire and triggers kidnapping booms... Insurers have therefore created institutions to make sure that ransom offers meet kidnapper expectations and produce safe releases but that do not upset local criminal markets... Because insurers can communicate outcomes confidentially, they can stabilize ransoms — as well as discipline rogue kidnappers. One kidnapper summarized this perception in the criminal community as “No one negotiates with a kidnapper who has a reputation for blowing his victims’ brains out.” Crisis responders also manage the ransom drop, removing a further obstacle to a successful conclusion. About 98 percent of insured criminal kidnapping victims are safely retrieved.

Of course, this “protocol” for ransom negotiations is costly. Tough bargaining takes time, imposing huge psychological costs on negotiators and on the victim’s family and tying up productive resources in firms. Experienced consultants are paid a substantial daily fee. It is very tempting to conclude negotiations early. Most of the cost of quick ransoms that are bigger than they ought to be is borne by future victims and their insurers, not the current victim’s stakeholders...

It would be impossible to prove beyond reasonable doubt that an insurer’s crisis responder deliberately cuts corners because ransoms are naturally variable. This makes it impossible for insurers to formally contract with each other and punish those who “overpay” kidnappers. Insurers resolve this through an ingenious market structure. All kidnapping insurance is either written or reinsured at Lloyd’s of London. Within the Lloyd’s market, there are about 20 firms (or “syndicates”) competing for business. They all conduct resolutions according to clear rules. The Lloyd’s Corp. can exclude any syndicate that deviates from the established protocol and imposes costs on others. Outsiders do not have the necessary information to price kidnapping insurance correctly: Victims are very tight-lipped about their experiences to avoid attracting further criminal attention. The private governance regime for resolving criminal kidnappings generally delivers low and stable ransoms and predictable numbers of kidnappings. Most kidnappings can be resolved for thousands or tens of thousands of dollars. This makes profitable kidnapping insurance possible. When the protocol fails, insurers sustain losses and must innovate to regain control.

This should count as one of the very rare examples of how the market has addressed the co-ordination problem that is pervasive in such situations.