Imagine that your job involves negotiating with international criminal organizations or, at the very least, assisting those who do. No, you do not work for some mercenary military force or in illicit arms and drug deals; you work in insurance. It may seem like the start of a movie, but it is a very real segment of the insurance industry, generating hundreds of millions of dollars in premiums annually. What is this line? It’s kidnap and ransom (K&R) insurance, which, in the modern world of global expansion and technological revolutions, is a virtual necessity for major players in every market and a major opportunity for the insurance industry.
An emerging line
K&R insurance originated following the kidnapping (and eventual murder) of Charles Lindbergh’s baby in 1932. It remained a niche coverage form, covering celebrities and their families, and was relatively unused in the U.S. until the Patty Hearst abduction in 1974. From that point on, policies became more and more popular among the Hollywood elite. Today, the major purchasers of this coverage are large companies with a significant international presence. The policies are designed to protect individuals and corporations operating in high-risk areas around the world. Over the years, policies have evolved from covering named individuals to covering named categories of persons (family, employees, employers, etc.) of a covered individual. The coverage is typically offered along with other management liability lines such as directors and officers. Lloyd’s of London, which has a reputation for focusing on just this kind of specialist insurance in the international market, has a long tradition of providing kidnap and ransom policies. While there is personal lines availability for persons such as freelance journalists, mission workers or high-net-worth families, this article focuses on commercial K&R coverage.
There are four major perils covered by the typical K&R policy: kidnapping, extortion, detention and hijacking. Some policies now cover cyber-threats under their extortion coverage, which may overlap with companies’ cyber-perils policies. Overlapping cover can also occur in the context of piracy at sea, where traditional marine cover may meet the cost of the ransom but will not meet the (usually very substantial) costs involved in the crisis management process. K&R policies are indemnity policies; they reimburse for losses incurred by the insured. Types of losses can widely vary, and include: ransom payments, loss of ransom in transit, medical expenses for the victim, psychiatric expenses, reward payments, asset protection, funeral expenses, child care expenses, business interruption expenses and, perhaps most importantly, the fees and expenses of crisis management consultants.
All major K&R policies include the cost of services of crisis management and security consultants, which can be thought of as loss mitigation teams. These consultants provide advice to the insured’s family or employer on how best to respond to the incident. Should the local authorities be contacted, or even trusted? How can you make the kidnappers prove they have your employee? Where should you meet with the kidnappers? How should you deliver the ransom? These are not easily answered questions, and most likely should not be answered by someone at your company. Crisis managers have accumulated a wealth of expert knowledge about economic kidnappings. They take the tremendous burden of dealing with kidnappers away from a company or a family and prevent emotions from taking over and exacerbating an already tenuous situation. These firms have a relationship with kidnappers. They know who to trust, who can be bribed and how much resolution is going to ultimately cost. Typical policies do not cap the expenses that can be paid to crisis management teams.
Coverage for a unique population
A unique feature of K&R policies is that the personnel covered by a policy most likely do not (and cannot) know that they are covered. Policies are typically purchased by a company to cover key personnel traveling in dangerous areas of the world. If those covered were aware of it, it would likely change their activity, potentially increasing the risks they take. In extreme cases, it could even lead to collusion between kidnappers and potential victims. For instance, if a covered individual knew that a company had coverage and would pay in the event of a kidnapping, he or she might work with kidnappers for a portion of the payout. Clearly, it is in the best interest of the companies that those covered remain unaware of the coverage or, more realistically, unaware of the limits and conditions of the specific policy purchased.
This scenario leads to some obvious ethical questions and some unusual adverse selection questions. Does the existence of this coverage actually increase the propensity for organizations to commit kidnappings? While evidence exists that the number of kidnappings has increased dramatically over the last 20 years, especially post-9/11, it is not possible to differentiate between the potential moral hazard inherent in a K&R policy and the increased “riskiness” of doing business because of globalization, population increases and global financial unrest. In the 1980s, the United Kingdom’s Prime Minister Margaret Thatcher launched an investigation into the policies. She was concerned that the existence of the coverage might encourage policyholders to pay ransom and might allow them to be less cautious about the amount of ransom they paid. Nothing came of that investigation and, while tension between governing authorities and insurance providers remains, the coverage continues to grow today.
Another potential dilemma arising from the existence of this coverage is whether a victim’s company will even inform the insurance company. The vast majority of kidnappers demand that no one be informed about the occurrence. Companies need to balance this demand with the need to contact authorities or the insurance company. If a company does not inform its insurer of the kidnapping, the insurer will likely try to deny coverage; however, if it does inform their insurer, it is potentially jeopardizing the employee’s life. As mentioned, there is also the potential ethical dilemma of negotiating with, and potentially making payments to, kidnappers. In the event that the kidnapping is perpetrated by a known terrorist organization, as is becoming more common in Middle Eastern states, the victim’s company may be placed in the awkward position of having to negotiate with terrorists, against the advice and publicly stated goals of Western democracies. It is important to remember that negotiating with terrorists is not encouraged.
Financing kidnap and ransom policies
Typical K&R policies are relatively inexpensive (when compared with directors and officers coverage) but are also very profitable because of the low frequency of the losses. Basic policies start as low as $500 a year, though pricing depends on the situation. Underwriting a K&R policy is like underwriting any other type of insurance. There are pricing incentives for good (less risky) behavior and penalties for bad (riskier) behavior. Underwriting characteristics used vary from company to company but often include the nature of a company’s business, total revenue, number of employees, travel patterns and foreign locations of employees, as well as previous loss experience.
The market, while still small, is growing. Kidnapping is estimated to be a $500 million a year criminal activity (as of 2010), a large portion of which comes from K&R payments, most of which is funded by insurance companies. At the same time, it is nearly impossible to know how many policies are in force worldwide. This is primarily because of the secrecy of the coverage. The presence of the coverage will never be mentioned in stories about a kidnap victim’s release. The policies are not paying the ransom; they are almost always reimbursing the company that does. Because of the secret nature of the policy, information about specific cases is hard to come by. Beyond that, according to Red24, a non-broker specialist in crisis management circles, it is estimated that 30,000 “traditional” kidnappings (i.e., those with ransom demands), occur every year worldwide, though the New York Times reports that only 10% of kidnappings are reported to the authorities.
While it is difficult to gauge potential future markets for this coverage, it is also difficult to determine who already has the coverage in place. What is not difficult to see is the financial impact the kidnappings themselves are having on companies. The non-profit group Oceans Beyond Piracy reports that maritime attacks by Somali pirates alone cost the shipping industry more than $5 billion in 2011, and the Economist estimated that Somali pirates alone generated more than $200 million in annual premium at the peak of their attacks in 2010. Most common targets of kidnappers are the oil and gas industry, because of the perception that energy companies are exploiting Middle Eastern nations’ wealth for their own benefit. Media outlets are also prime targets, primarily because of the exposure a kidnapping would generate.
A new breed of kidnapping risk
It is not just kidnappings for ransom and pirate attacks that companies need to be cognizant of. A relatively newer phenomenon is that of the “express kidnap,” of which there are on average 6,000 a year in Mexico alone. In these instances, there is no demand for a ransom made by a third party. Instead, the kidnappers take their victim to an ATM or a hotel room and make the victim access cash or personal valuables. The vast majority of these instances go unreported, mainly because of the corruption of the local law enforcement. In fact, studies say that half of the express kidnappings in Mexico are perpetrated by law enforcement agents themselves.
So, not only do kidnapping and ransom policies have to cover the low-frequency, high-severity, kidnap-for-ransom losses, they also must cover (relatively) high-frequency, low-severity, express kidnappings.
An evolving risk
It appears that kidnappings are increasingly being thought of as a business opportunity. Groups that have previously kidnapped purely for political purposes are now realizing the economic value. Most kidnappings are now orchestrated by professional gangs and groups, and dealing with them is more similar to a business negotiation than with a criminal organization. Kidnappers are getting smarter and are, on an increasing basis, being aided by crooked politicians and law enforcement agents. Kidnapping victims are seen as inventory and, as with any other business, the goal is to sell the inventory, not destroy it.
As kidnappers get smarter, companies that deal in areas that present a high risk for kidnapping must also learn to prevent losses. Having a kidnapping and ransom policy protecting key employees is common sense and should be regarded as an industry best practice for risk management. As globalization continues to expand, companies should see the need to take precautions to protect their “human capital.” Clearly, avoiding zones with a high level of kidnappings is ideal, but in the event that your company must do business in these areas K&R coverage can provide an important backstop. Kidnap insurance will always be veiled in secrecy out of necessity, but that does not mean there is not a place in the industry for growth and innovation.
As the demand for the coverage increases and the market continues to grow, it is natural to expect innovation in pricing. Clearly, there is very little historical loss data from which to develop reliable models, and most pricing is done on the basis of expected loss ratio. However, there is likely value to be gleaned from analyzing travel patterns, regional economic/political unrest and companies’ international strategies. K&R coverage is currently buried in the “other liability” line of the NAIC annual statement. At present, it is an extremely profitable coverage. But, like other lucrative practices, as more and more insurance companies see the potential for profits, loss ratios will go up as premium rates are minimized. A company that can most accurately forecast aggregate kidnapping activity and price policies accordingly stands to gain significant profits.
The goal, of course, is to reduce the opportunities for kidnapping. K&R policies encourage those who have personnel at risk to manage that risk more effectively, by providing rate relief for firms that engage in less risky activity. Insurers want to do all they can to minimize their policyholders’ risks, to reduce the likelihood they will have to pay out at all. The insurance companies do not profit from the loss occurrences; they prevent their insureds from having to liquidate assets because of acts of terrorism. The policies align with the government goals of reducing terrorist activities. They do not exacerbate the problem; they play a necessary role in reducing the impact of traumatic events. This coverage will grow significantly as the number of companies operating internationally increases and as international markets in which companies operate continue to expand. It is vital that these companies obtain this coverage for their key employees. It could save their business…or an executive’s life.