Crafting an Effective Protection Contract

Firms cannot operate safely in rebel territory without making security arrangements with local powerbrokers. How does one make a protection contract with an armed group that is both self-enforcing and plausibly deniable? Protection contracts have prisoners’ dilemma characteristics: cooperation is only sustainable with indefinite time horizons or effective sanctioning mechanisms. This chapter discusses seven different options that are appropriate in different contexts and can also be deployed in parallel. Firms—advised by security consultancies—choose the options that minimize the total costs of obtaining security. These include production costs, transactions costs, and the potential reputational costs of engaging with rebel movements or deploying (para)military forces against local opposition groups.

Debrief

This chapter concludes the book with four reflections on how readers can shift power away from kidnappers, protect at-risk populations, and safeguard hostages. First, hostages can help smooth their own release by not volunteering financial information to their kidnappers. Second, stakeholders who understand how hostage negotiations work are less likely to inadvertently strengthen the bargaining position of the kidnappers. Third, politicians should recognize the counterproductive nature of the UN ban on ransom payments to terrorists as it is currently practised. Its reform would increase public security. Finally, a better understanding of the power of private governance should reduce public demands for government interference in this tricky, politically sensitive, and ethically problematic market.

Why Do Hostages Die?

Every hostage negotiation has the potential to end badly—yet almost all insured criminal kidnaps end with a safe hostage release. This chapter analyses under what circumstances abusing or killing hostages is a rational choice. It shows how private sector negotiators shape kidnappers’ pay-offs to encourage cooperative behaviour. When a kidnapping gang is reclassified as terrorist, the parameters of bargaining change substantially. Putting well-resourced but nervous and inexperienced civil servants in charge of negotiations results in the escalation of ransoms. Murder and torture for reputation drives up the prices for hostages from nations whose governments are willing to engage with terrorists. The UN ban on ransom payment therefore has unintended and counterproductive consequences.

Trading with Kidnappers

Once a price is agreed, kidnappers tend to demand payment in unmarked, small-denomination notes. How do people deliver the cash to the right addressee without putting themselves at risk? How do kidnappers collect it without being apprehended? And why would they release a potential future witness after getting the ransom? This chapter analyses how these tricky logistical, contracting, and enforcement problems are resolved in practice. Different solutions are appropriate in different local contexts and price segments. We observe a vibrant market for (cost-)effective solutions to trade problems and intense evolutionary competition between providers. Market concentration and excellent information flow ensure great financial rewards for successful innovators.

Understanding Patterns of Kidnapping

Protection theory predicts that if a society is capable of producing surpluses, people specialize into production, trade, and protection. The protector facilitates production and trade by safeguarding people, enforcing property rights, and adjudicating disputes and is paid for providing these services. Protection can be provided by states, rebels, or mafias: tax and extortion are often closely related in practice. Why would protectors kidnap citizens in their own territory? This chapter shows that kidnapping is disequilibrium behaviour: abductions occur when citizens (or visitors) refuse to pay protection money, do not know who to pay, or how to pay their protector, and when protectors need more information to price their services. Most kidnaps occur in disputed territories, where there is a disequilibrium in the market for protection.

The Protector’s Choice

When does a protector permit and facilitate the kidnapping of outsiders? Protecting criminals can be very lucrative. Effective protection increases the returns to crime and the protector can extract that surplus. Yet, engaging in crime and cooperation with criminal groups can undermine the legitimacy of the protector among the ruled and disrupt other taxable economic activities. Moreover, the protector risks being challenged by the criminals if their business becomes unexpectedly profitable. This chapter uses the example of Somali piracy to show that protectors only facilitate criminal activities if there is a net benefit from doing so. Usually, crime is only an attractive revenue source in economically remote areas and when the protector needs money to fight political or territorial challenges.

Governing Kidnap for Ransom

Kidnap insurance depends on orderly and stable markets for protection and hostages. The governance system for these three interlinked markets is best described as polycentric—i.e. consisting of multiple decision-making centres. Agents employed by the insurers are motivated and disciplined through financial incentives and peer monitoring. However, the system also needs an effective and completely confidential enforcement mechanism that compels all insurers to comply with the market-stabilizing norms and protocols. This is achieved through club governance. Insurers must be members of the Lloyd’s club to access crucial market information to operate profitably: losing club membership is the ultimate sanction in this market. We thus observe a polycentric system governed by a members’ club. Cases settled by outsiders threaten the stability of the system.

The Case of the CEC Future

How do you set a mutually agreeable price for a fully laden ship and crew held by pirates? This chapter analyses the transcript of a real pirate ransom negotiation in the light of the economic theories of price formation in anarchic bargaining developed in Chapter 6. Personalities assert themselves, tempers fray, and both negotiating parties split in the stress of the negotiation. Principals and agents are divided and regroup in new ways. The negotiation demonstrates both the wisdom of the Lloyd’s protocol and the difficulty of applying it in real life. Having witnessed this tense negotiation conducted in 2008/9, we understand why Somali pirate ransoms spiralled out of control.

The Price of a Life

Ransom discipline is paramount for kidnap insurance and provides wider social benefits. Outsize ransoms can trigger a vicious cycle of kidnappings, hostage abuse, and ransom inflation. Crisis responders have developed a robust bargaining protocol to stabilize ransoms and incentivize cooperative behaviour by kidnappers. Kidnappers only release hostages when they think they have extracted the maximum available ransom. This requires that hostage stakeholders send psychologically costly signals to convince kidnappers that their funds are exhausted. However, if hostage stakeholders believe that there is a trade-off between time and money in a hostage negotiation, the bargaining protocol creates the (false) impression of a principal–agent problem between professional negotiators and stakeholders. Managing the resulting suspicion and distrust is as important as shaping the negotiation with the kidnappers.

What is Kidnap for Ransom Insurance?

Kidnap insurance comes with stringent conditions and access to a range of services for kidnap prevention and kidnap resolution. The market is highly concentrated: there are only around twenty underwriters in this niche business area and all of them operate syndicates at Lloyd’s of London. They have created common protocols to manage adverse selection and moral hazard among the insured and to order transactions across the legal/extra-legal boundary. These protocols are set, monitored, adapted, and enforced by a range of experts. The community of experts is small and cohesive and communication networks are dense. We observe a vibrant market for outstanding governance specialists. Good reputations and successful innovations ensure high incomes, but failures quickly lead to expulsion from the circle of trusted providers.