News that president Obama will no longer threaten families that pay ransom with prosecution has pleased some, but worried others. USA Today reports, “President Obama unveiled new rules Wednesday that would basically allow families to offer private ransom payments for relatives kidnapped overseas.”


While the federal government will continue to refuse to make ransom payments, Obama and other officials said families will no longer be threatened with prosecution if they seek to do so privately.

“I’m making it clear that these families are to be treated like what they are — our trusted partners and active partners in the recovery of their loved ones,” Obama said in announcing the changes from the White House.

Before examining the pros and cons of this new policy it may be helpful to review the economics of ransom. Megan McArdle describes the problem succinctly in the Atlantic.

Economists would describe hostage negotiation as a bilateral monopoly price negotiation that is structurally just a special case of chicken. That is, unlike a barrel of oil or a freight car full of soybeans which can trade on an extremely liquid market with innumerable buyers and sellers, a hostage has exactly one seller (the kidnappers) and exactly one buyer (the employer and/or family of the hostage). When there is only one buyer, the opportunity cost for ransoming the hostage is zero. Likewise, the employer and/or family has no realistic alternative means to recover the hostage. In order for everybody to walk away happy, we need a cooperate-cooperate outcome: the kidnapper has to give up the hostage and the employer/family has to give up a ransom. This structure also characterizes art theft, which in practice is not a matter of fencing art on the black market but ransoming art to a museum’s insurance company.

The problem the hostage taker must solve is what can he charge? Only as much as the victim’s family and friends can pay.  If the kidnapper is unwilling to accept more than can be afforded and kills the hostage, he essentially gets zero from the transacation. The perp’s best bet is to hold out only for as much as he can realistically expect to be paid.

Back in the days when I worked staff support in negotiations with Muslim rebels in Mindanao the wives of kidnapped roadmenders used to rattle begging tin cans along the road trying to raise money to ransom their husbands or sons from the rebels. About $50 American would do it since rebels knew that was about as much as a destitute woman in Basilan could raise.  However, if the rebels believe they had a more valuable captive such as a public works supervisor, then they might ask for more.


If bandidos board a provincial bus they will most likely rob the passengers. As long as most of them are peons, none of them are worth the trouble kidnapping. Not at fifty bucks a head. But if they run into someone with blond hair and blue eyes the cry will go up, “a Gringo!!” and the game changes for that man because suddenly they have come upon a person worth kidnapping.  Being kidnapped is not always the worst outcome. If the bandidos had originally intended to kill everyone on the bus being the gringo might make the difference between living or dying.

The dynamics of perceived value was illustrated by a kidnapping that happened about 3 years back to someone I knew who stopped by some rebels. They took his cell phone and money and would have let it go at that before noticing some recognizable names when scrolling through the phone’s telephone directory. That changed his value.  He spent 2 years a prisoner until the negotiators could raise the demanded price.

Megan McArdles article explains why information is so important to the economics of kidnapping.

If we model a bilateral monopoly negotiation only two things should matter. The first is, as always in a game of chicken, the willingness to accept failure. The more willing you appear to walk away, the more bargaining power you have. In a more protracted game this can cash out as willingness to delay which we can treat as a defect-defect outcome on the installment plan. In fact in the Planet Money episode on Somali piracy, the hostage’s party did balk and break off negotiations for weeks at a time until the pirates were willing to come down on price.

The other thing that should matter is the capacity to pay. If the pirate knows for an absolute fact that the hostage’s people simply can’t raise more than a million dollars then it would be pointless for them to demand two million dollars. Of course there is an issue of information asymmetry in that the hostage’s party has much better information on its assets than do the pirates and so the pirates may be skeptical of the hostage’s party pleading poverty (especially if the hostage has foolishly told them how much money they can get).

The need to maintain information asymmetry is why nearly all Kidnap and Ransom insurers required that the insured parties remain ignorant of their coverage. “One of the known paradoxes of K&R policies is that those who have them are often not aware, as it can be provided by an employer hoping to protect the company’s assets. It is believed that an employee with knowledge of his K&R policy might begin to act differently, or even collude in his own kidnap for fraudulent purposes”.


McArdle says classic economic theory suggests that because each ransom transaction is sui generis, there can be no market price but acknowledges that certain factors, like nationality or race, convey price information that bounds the transaction. “This is consistent with the Planet Money story in that Filipinos are cheaper to ransom than Europeans by an order of magnitude. Presumably this reflects Bayesian inference on the part of the pirates from the hostage’s nationality as to how much the hostage’s party should be able to raise.”

It has become harder to maintain information asymmetry because of the Internet.  I remember telling one African American USAID official who was worried about running into the Communist New People’s Army on a trip to Zambales to say, in case he was captured that he was visiting his negrito relatives and to claim he was the son of a negrito mother and an American father.

That would have worked then, but it’s unlikely to work  in the Google Age.   Today someone would take out a smart phone and do a search. Facebook, Twitter and Linked-In are very good substitutes for the cell phone telephone directory that sank my friend.  Bayes is even more important because small time rebels often on-sell hostages to bigger gangs who have historical data.  They may for example, know from previous experience whether an employee has employer provided K&R insurance even if the employee does not.

One thing that can confuse kidnappers (along with everyone else) is the effect of government regulation on K&R coverage. Forbes writes that the State Department sometimes makes it hard for K&R to work.  “The U.S. government, along with many foreign governments and agencies, issues worldwide and country-specific warnings and advisories for places where citizens are at risk of being kidnapped. Kidnap/ransom policies often limit or exclude coverage or sometimes raise deductibles in regions and countries for which such warnings are issued. If your company does business in one of those places, and your employee is kidnapped there, the insurance company may try to limit or void coverage altogether.”

The last company employed kidnapped might have had insurance, and while Bayes might suggest the current guy from the same firm is worth the same amount a travel advisory or some government restriction may have voided the policy.  And so the kidnappers can think you’re holding out gives the current captive the chop.  Bayes can lose to the government.


In a sense Barack Obama’s policy change isn’t offering to get the kidnapped parties off the hook from the terrorists or criminal gangs so much as offering to get the government off their backs.  “I can’t help you but at least I’m not going to make it worse”.  Gee, thanks.

There is one other thing worth considering in the economics of ransom. The risk to the kidnappers. The difference between the kidnapping of Europeans in the Sipadan dive resort in 2000 and the Dos Palmas kidnapping of Tim and Graciela Burnham wasn’t the rescue operation.  There wasn’t much success at that. The difference was in the “subsequent events”. Nearly everyone involved in the Burnham kidnapping either died or faced a long stretch.

The search for the hostages eventually led to a six-month deployment of 1,000 American troops who provided training and high-tech support to the Filipino troops.

In July 2004, Gracia Burnham testified at a trial of eight Abu Sayyaf members and identified six of the suspects …  Fourteen Abu Sayyaf bandits were sentenced to life imprisonment on December 6, 2007 as result of the attacks; four were acquitted. Alhamzer Limbong was later killed in a prison uprising.

The perceived risk to kidnapping an American in the Philippines was therefore higher than kidnapping a European. That’s not always a good thing, as there may be an incentive to kill an American hostage where a European may be spared because U.S. citizens are “trouble”.  But deterrence is often valuable.  In fact you can argue ransom policy is less important than retribution policy.  The most famous, though perhaps apocryphal story of the power of retribution is about a Russian diplomat who was kidnapped by the Hezbollah in 1986.  The LA Times version is:

The incident began when four Soviet diplomats were kidnaped last September by Muslim extremists who demanded that Moscow pressure the Syrian government to stop pro-Syrian militiamen from shelling rival Muslim positions in the northern Lebanese city of Tripoli.

The militiamen, the Jerusalem paper said, did not cease their attacks, and the body of one of the Soviet diplomats, Arkady Katkov, was found a few days later in a field in Beirut.

The KGB then apparently kidnaped and killed a relative of an unnamed leader of the Shias’ Hezbollah (Party of God) group, a radical, pro-Iranian group that has been suspected of various terrorist activities against Western targets in Lebanon.

Parts of the man’s body, the paper said, were then sent to the Hezbollah leader with a warning that he would lose other relatives in a similar fashion if the three remaining Soviet diplomats were not immediately released. They were quickly freed.

The newspaper quoted “observers in Jerusalem” as saying: “This is the way the Soviets operate. They do things–they don’t talk. And this is the language Hezbollah understands.”


Maybe the story is apocryphal. But like Keyser Soze, you only have to believe the Russians will do it for it to be true.  It’s probably fair to say that Russians, like Filipinos, aren’t worth kidnapping, though for different reasons.

Ransom policies by themselves are only meaningful in the broader context. A ransom policy yoked to an aggressive intelligence and hostage rescue or retribution program can be more effective than a no-ransom policy without the accompanying intel and vengeance operations. Kidnappers have to expose themselves in the negotiating process. Paying ransom, as the police well know, is sometimes the only way to catch the perps.

One of the biggest benefits of K&R insurance isn’t the insurance itself but the experienced negotiators it often buys.  The negotiators can be the biggest source of intel.  If you really have to try a desperate rescue, at least you’ll know the ballpark.  Without experienced guys you at everyone’s mercy.

The CFO of XYZ Global Oil & Drilling gets a call at 4:50 p.m. on a Friday. … Here are the immediate problems presented to this individual: Who do I call at 5:00 p.m. on a Friday? Do I call the local police, the FBI, the CIA … who? What security firms can I contact? Is the call for real? …

Even if there are ample resources, there is no guarantee that our CFO will have security consulting firms jumping through hoops to bid this very difficult assignment at the last minute, even for an extraordinary amount of money. They have their reputation to think of, and it’s worth 100 times what you can offer to pay them to “jump on this case” with little time, and a chance of the operation being unsuccessful. Finally, having an appropriate professional to outsource this nightmare situation is critical, especially to mitigate the legal liability … Let the professionals make the determination.

The worst of all possible worlds of course is encouraging ransom payments while reducing military or law enforcement action. That’s like ringing the dinner bell, or replacing the American flag with a white sheet and yelling, “come and git it”.

Mindanao went wild after the 2000 Sipadan kidnapping as the Abu Sayyaf used the millions they got from the Europeans to buy weapons. They kidnapped lots and lots of people in the aftermath. Arguably the Europeans had no choice, as they have no assets worth the name in the region. In the case of the Burnhams the effect was far different. Sure kidnappers got paid. But the only place most of them got to spend the money was in hell.


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