Medieval knights and barons rarely fought the pervasive bandits who besieged their castles. Ransom was a more common outcome. Also, the Torah requires Jews to ransom our compatriots. We, however, proclaim ransom to be unacceptable.

The effect of ransom is shifting the risk from the current victim onto future innocents. Ransom spares some, but encourages the terrorists to take other hostages. In our case, the other hostages are also Jews, and we care about them.
Medieval barons, however, were too sparse to form a society. None of them cared about the others, and each averted the risk for himself by paying ransom and thus encouraging the bandits to besiege others.
The Torah’s case is also different. Modern hostages have no value other than for ransom; ransoming them increases the value of subsequent hostages (for exchange), while refusing to ransom them discourages the kidnappers from subsequent attempts. In antiquity, hostages had intrinsic value – they could be sold as slaves. Refusing to ransom them wouldn’t have discouraged the kidnappers, who could just as well get their money by selling the kidnapped Jews into slavery.
When the hostages lacked intrinsic value (for example, if they were old) and were only captured for extortion, they should not be ransomed so as to avoid setting a precedent for the kidnappers; thus, Rabbi Meir of Rothenburg in the thirteenth century prohibited his community to ransom him. The rabbis long recognized the problem of intrinsic value, and Talmud (Gittin 4:6) prohibits ransoming fellow Jews for more than their market value as slaves. The sages recognized that no law can stop close relatives from rescuing their dear one; a husband is allowed to redeem his wife at the first opportunity for ten times her market value as a slave. But that is his right, not the community’s obligation.

Refusing to ransom fellow Jews from terrorists is no more morally objectionable than limited funding of free medical programs or road safety. We’re our brothers’ keepers only to an extent. Would an Israeli government promise to refrain from shooting at a thousand enemies on the battlefield in exchange for them not shooting at a single soldier?

The one thing worse than ransoming hostages is prisoner exchanges.