Thursday, April 4, 2013

Is kidnap insurance a good thing?

In some countries, kidnapping for ransom has become a common and profitable business. It does not strike as an added-value generating activity, but one has to live with it. One way in which markets have responded to this is that it is now possible to by kidnap insurance that pays ransoms. Is this a good thing? Indeed, kidnapping frequency may increase if there is a higher likelihood that a ransom is going to be paid. That is not unlike US colleges that charge higher tuitions because they can, as public funds for students grants and loans have been ramped up. But let us keep talking about criminal kidnapping.

Alexander Fink and Mark Pingle look into this issued. The first question one may ask is whether this kind on insurance is sustainable in the first place. Indeed, many insurance markets fail due to adverse selection or moral hazard issues. In this case, risk aversion on the insureds is high enough that they are willing to pay premiums sufficiently above what would be actuarially fair. Indeed, there is a risk of getting somebody killed, and optimal kidnappers would want to randomize over this just to make sure that they can extract the most. The presence of insurance will increase the number of kidnapings, but if it does not do this too much, one should see a reduction in killings. We can thus not unambiguously say that kidnap insurance should be allowed.

1 comment:

Tim Worstall said...


The real point of kidnap insurance is not actually to pay the ransom. It's to have on retainer the people who know who is kidnapping, why they are doing so and what is the market price.

Sure, it's an "insurance company" that provides the insurance but in reality it's a group of Special Services guys who know the area, groups, prices and so on.

To an extent, what is being purchased with the premium is "should we pay or should we go kill them all?" advice.