I generally believe in the power of markets and competition. They aren’t perfect, but they are very good at creating value in society. I also appreciate pharmaceutical firms for creating innovations that have allowed us to live longer and healthier lives. In fact, I have proudly provided consulting and teaching services to many of these companies. But I don’t like the corrupt practices of pharmaceutical firms that limit the effectiveness of markets, steal value from customers, and destroy overall societal value along the way. We allow this particular type of corruption too often.
Rising health-care costs are a pressing societal problem in the United States, which far outspends any other country on health care. Prescription drugs make up a significant percentage of these costs, about 10 percent in 2017.1 Extreme drug prices typically occur when a pharmaceutical firm has a monopoly over a particular drug. Generic drugs dramatically reduce costs by breaking these monopolies. But some branded pharmaceutical firms go to great lengths to keep generics out of the market—often by behaving corruptly.
To encourage innovation, governments allow pharmaceutical firms to obtain patents, which encourage them to innovate and disclose those innovations by allowing a temporary monopoly to recoup the investments made during the development period. When drug patents expire, generics can enter the market, at which point drug prices plummet—often by as much as 80 to 90 percent. The government must try to strike a tricky balance between creating an incentive for companies to create new drugs, via longer patent periods and more restrictions on bringing related products to market, and increasing access to drugs for the most vulnerable in society, by allowing generic companies to bring lower-priced drugs to market. To interfere with this cycle and keep their monopoly profits, pharmaceutical firms sometimes indirectly pay generic competitors to stay out of the market. While it is illegal to pay directly, branded firms accomplish this goal by overpaying for “side deals.”
The first documented case of a branded pharmaceutical firm paying to keep generic drugs out of the market occurred in 2001 when the Federal Trade Commission (or FTC, which is responsible for preventing the illegal restriction of trade) brought a lawsuit against brand-name drug producer Schering-Plough and generic producer Upsher-Smith.2 Upsher-Smith had been on the verge of introducing a generic version of K-Dur, a potassium chloride supplement used to correct low potassium in the blood, which was a near-monopoly drug for Schering-Plough. Upsher-Smith argued it could introduce its product to the market without violating Schering-Plough’s patent. Schering-Plough sued Upsher-Smith for patent infringement to try to keep it out of the market. Rather than fighting the dispute in court, however, the two companies ended up negotiating. They reached a deal in which Upsher-Smith agreed to wait until very close to the end of Schering-Plough’s patent to sell a generic version of K-Dur and, in the very same legal agreement, to accept $60 million from Schering-Plough for five unrelated patents. The FTC sued both companies, arguing that the $60 million wasn’t actually for the five unrelated patents but rather was primarily a payment to keep Upsher-Smith out of the K-Dur market and allow Schering-Plough to maintain its monopoly prices.
In response to the FTC’s accusations, lawyers for the pharmaceutical firms argued that making trade-offs across issues created value and was therefore beneficial to society. This view was supported by a well-recognized expert in dispute resolution, who highlighted value creation as one of the major contributions of the negotiation literature. This argument follows directly from the logic I presented in Chapter 3: parties who expand the pie by adding issues to the discussion move to the northeast of the negotiation diagram in Chapter 3 and generally create value for the two parties at the table. But, as James Gillespie and I have argued, value-creating deals typically aren’t good for society if the value created is shared by only two colluding firms at the expense of their customers, who would end up paying more as a result.3 When two firms create value by taking it from parties not at the table (those who need the drug), parasitic value creation has occurred.
As an expert witness in the Schering-Plough/Upsher-Smith case, I argued that allowing the firms to collude by combining patent settlement with side deals would create a blueprint that branded pharmaceutical firms with monopolies could follow to pay competitors to stay out of the market. By justifying sham payments, the pharmaceutical firms would skirt the law, with little concern for the harmful effects of their actions on consumers and, more broadly, society.
The administrative law judge hearing the case ruled against the FTC, largely arguing that it had not produced evidence connecting the market delay to the $60 million payment. The FTC commissioners overruled the administrative judge in a 5–0 ruling, across party lines, based on the observation that these two hostile firms would not have reached the two agreements independently. The pharmaceutical firms, however, won once again on appeal, and the Supreme Court refused to hear the FTC’s appeal further. It is my opinion that the administrative law judge provided a publicly available playbook for future parasitic integration among competitors. In the two decades since, many pharmaceutical firms have followed the blueprint provided by the administrative law judge and the appeals court to extend their monopolies on drugs, often with greater deniability and complexity.
The strategy is pretty straightforward: sue any competitor that threatens your monopoly, then settle the case to delay the generic drug’s entry into the market and vastly overpay the potential new entrant for some unrelated side deal. After the FTC sued it for reaching this type of deal, brand-name pharmaceutical firm Cephalon agreed to pay a $1.2 billion settlement in 2015. The case was much more complex than the Schering-Plough case, and Cephalon never admitted to violating the law. However, the company’s willingness to settle for $1.2 billion—billion, not million—suggests the FTC had solid evidence that the brand-name manufacturer was paying a generic manufacturer to delay market entry. How else to explain such a huge settlement?4
Sana Rafiq and I have argued that when two pharmaceutical companies are involved in a patent litigation lawsuit, they should be prohibited from engaging in any linked, unrelated business transactions.5 Because these side deals are most likely disguised payments to delay entry of a competing product, prohibiting any simultaneous business transaction between the two litigating companies would limit their ability to have the branded firm make unusually large payments to the generic company for unrelated agreements.
At this writing, no such stipulation exists, and the pattern of pharmaceutical companies parasitically creating value by stealing that value from consumers continues. The deals are complex enough that consumers don’t pay attention to them; they simply complain about the high cost of drugs. Failing to act on this pattern across cases, the judiciary treats each case as unique and ignores the fact that the payments for the side deals always go from the monopolist to the entrant. Meanwhile, pharmaceutical firms use their profits to lobby Congress and make campaign donations, to discourage legislative changes that would have the power to interrupt their corruption.
By the way, some might be concerned by the simultaneity of me speaking up against corruption, while also getting paid by the FTC as an expert witness. Do I believe my own arguments, or am I simply saying what needs to be said to earn significant fees? This conflict of interest was a concern to me. To resolve it, I have made it a practice to commit to donating 100 percent of the fees from this work to charity, a commitment that is always spelled out in my testimony. This commitment allows me to create value, by both fighting corruption and contributing the proceeds to effective philanthropies.
Rather than simply complaining about the high costs of drugs or saying, “That’s just the way it is,” we ought to notice corruption like this when it is occurring in our organization, city, state, or country. That means recognizing corruption as more than a bad act. We need to call it out as a behavior that moves us further away from the North Star of creating as much value as possible. How can we do this? We can do this with our vote, our political actions, and our willingness to stand up when corruption exists around us.
CORRUPTION DESTROYS MORAL AUTHORITY
Josh Campbell, a former supervisory special agent for the FBI, described on CNN.com “the power of the nation’s brand”:
Our reputation as a country dedicated to freedom and justice precedes all who are honored to identify themselves as American officials. While serving diplomatic and operational assignments with the FBI in over 20 countries, I saw the power of that brand up close. When I spoke, people listened. Not because I was an inordinately gifted orator, but rather because I was speaking on behalf of the United States government, an imperfect but often emulated conglomeration of agencies known throughout the world as reflecting righteousness, fairness, and truth. . . . As one American ambassador in South Asia described it to me, we are effective in every corner of the globe because of the moral authority generated at home by the manner in which we govern ourselves and our commitment to the rule of law.6
Moral authority creates trust and allows for greater cooperation, wise trades across countries, and value creation for the United States and for the world. Thanks in large part to this moral authority, the U.S. government has the power to create lots of value.
By contrast, corruption within government, particularly at the highest levels, does more than move money from the innocent to the corrupt; it destroys value and weakens the fabric of society. In 2011, Robert Mueller, then the director of the FBI, reflected on the high costs society pays for corruption:
You might pay more for a gallon of gas. You might pay more for a luxury car from overseas. You will pay more for health care, mortgages, clothes, and food. Yet we are concerned with more than just the financial impact [of corruption]. These groups may infiltrate our businesses. They may provide logistical support to hostile foreign powers. They may try to manipulate those at the highest levels of government. Indeed, these so-called “iron triangles” of organized criminals, corrupt government officials, and business leaders pose a significant national security threat.7
The more corrupt a government is, the more likely perverse incentives are to develop, while the most competent and honest public servants leave government in frustration. Competence gives way to political connections, waste, and incompetence; societal trust is weakened in the process. If government employees are rewarded for supporting corruption, corrupt systems will be institutionalized. Not surprisingly, the countries ranked as the most corrupt in the world are often the poorest and on a downward trajectory.
When government leaders attack our judicial system, and when citizens support these leaders, our nation as a whole sacrifices its moral authority, loses respect, and destroys value. When the White House undermines Special Counsel Robert Mueller’s investigation of Russian interference in the 2016 presidential election, the credibility of the U.S. judicial system is damaged. When the president refuses to reduce his own conflicts of interest and instead uses the nation’s highest office to enrich his business endeavors, the integrity of the presidency is undermined.
Corruption also puts our national security at risk. Why did the United States invade Afghanistan after 9/11? Most of us would like to believe our leaders were attempting to protect our nation and its allies from further attacks by Al Qaeda. To help create a safer and more prosperous Afghanistan, we helped to install Hamid Karzai as its new leader. Yet in her book Thieves of State, Sarah Chayes shows that American tolerance of Afghan corruption, as well as our own corruption, undermined our effectiveness.8 Chayes documents the enormous corruption of the Afghan government that the United States helped to install, the specific corruption of Hamid Karzai and his family, and the distrust that this corruption created in Afghan society. This corruption provoked resentment, revolts, and even extremist violence, Chayes argues. When the U.S. government accepts and acts in concert with this corruption, the U.S. military presence becomes the focus of citizens’ hostility. When we tolerate corrupt behavior from our allies, we lose our moral authority.
From the comfort of the United States, we often wonder how people in other countries could choose groups that we view as clearly corrupt to lead them. But as Chayes highlights, they are often selecting one corrupt entity to replace the corrupt entity that the U.S. government supports. Similarly, in his book Pay Any Price: Greed, Power, and Endless War, journalist James Risen details how corrupt payoff schemes by military subcontractors like KBR (formerly a subsidiary of Halliburton) to government officials and their relatives further reduce our government’s moral authority and the credibility of our claims that we are there to do good.9 Contractors may not officially be a part of the U.S. government, but citizens in the countries in which they operate perceive them as such, and they can destroy our moral authority through their actions.
Our government further sacrificed moral authority following the murder of journalist Jamal Khashoggi. Virtually all analysts believe that in 2018, Saudi crown prince Mohammed bin Salman ordered the assassination of journalist Jamal Khashoggi, which occurred when Khashoggi visited the Saudi embassy in Istanbul, Turkey. Khashoggi had been deeply critical of the Saudi regime, and the United States has viewed Saudi Arabia as a critical ally in a very difficult part of the world.
Soon after the murder, Turkish authorities released intelligence showing that the prince was behind the murder. Intelligence operations across the globe, including the CIA, were convinced that the prince had authorized the murder. Yet even after all of this evidence was in, President Trump declared strong support for Saudi Arabia. Trump obfuscated by noting that U.S. intelligence would continue to assess the story and by saying that we “may never know all the facts surrounding the murder.”10 Addressing the question of whether the crown prince knew about or ordered the killing, Trump said, “Maybe he did or maybe he didn’t!”11 Trump’s position did not change even after the New York Times reported that U.S. intelligence had a recording of Prince Mohammed telling an aide in September 2017 that he would go after Mr. Khashoggi “with a bullet” if he didn’t return to the kingdom and end his criticism of the Saudi government.12
Trump further indicated that Saudi oil production, purchases of weapons from the United States, and support for U.S. policies in the Middle East were more important to him than holding Saudi Arabia accountable for the murder of a journalist. “I’m not going to destroy our economy by being foolish with Saudi Arabia,” he said.13 Obviously, there was a short-term strategic benefit to not confronting our ally about its leader’s brutality and illegality, but Trump failed to understand or care about the long-term ramifications of continuing to chip away at American moral authority.
Moral authority belongs not only to government leaders, but to all of us. Patients are more likely to trust and follow the instructions of doctors who act with integrity. Negotiators who have moral authority more easily exchange information, find value-creating trades, and develop better relationships as compared to those who don’t. The moral authority of nonprofit leaders increases trust in the organization and facilitates fundraising and creative, effective, and efficient solutions to societal problems. And the moral authority of corporate leaders allows them to contribute the best that business has to offer society. In all of these realms, however, sacrificing moral authority inflicts damage far beyond the initial unethical behavior, reducing value for society as a result of the loss of trust in the person or the broader institution.
BUYING THE LAWS YOU WANT
Americans are often (rightfully) critical of other nations. We often criticize emerging economies where illegal behavior interferes with the operation of honest markets. We criticize nations where bribery of public officials is common. Yet we are less critical when our own leaders participate in corrupt actions that distort our laws in ways that favor special-interest groups and the leaders themselves over the public as a whole. Essentially, we have created a political system that allows corruption by distorting the law rather than breaking it.
The abuses that occur in the payday loan industry provide a glaring example of the way in which our political system can promote corruption. By offering short-term loans as advances on wages, payday loan companies provide the working poor and others suffering financial hardship with a means of obtaining emergency cash. In the best of circumstances, the consumer is able to repay the loan on her next payday. Yet payday loans, which have been available for about twenty-five years, carry interest rates ranging from 200 to 500 percent per year, and the average payday borrower takes out eight loans a year. On an average payday loan of $375, borrowers pay an average $520 in interest. While payday lenders and the lobbyists they hire to represent them in Washington claim they are meeting a need in low-income areas not served by traditional lending institutions, consumer advocates and independent analyses argue that these loans do far more harm than good. Most payday borrowers are unable to repay their debts in time and are left to choose between defaulting on their loans or borrowing more money and escalating their financial woes.
During the Obama administration, many states moved to regulate and in some cases ban payday lending, and the industry downsized. In addition, abuses in the payday loan industry partly inspired the Wall Street Reform and Consumer Protection Act, which President Obama signed into law in 2009. The act, which created the Consumer Financial Protection Bureau (CFPB), was intended to protect and educate consumers about payday lending, banking, securities firms, debt collectors, and other financial businesses. In 2013, the CFPB accused payday lenders of “trapping borrowers in a cycle of debt.”14
While the CFPB was politically volatile, having been largely created by a very liberal senator, Elizabeth Warren of Massachusetts, few politicians actively or publicly supported payday lenders. Yet since the election of Trump, payday lenders have corruptly purchased political changes that have improved their profitability while causing massive additional harm to borrowers. To head the CFPB, Trump installed Mick Mulvaney, a former congressman who received more than $60,000 in campaign contributions from payday lenders. Mulvaney was an outspoken supporter of the payday loan industry, yet he was chosen to oversee it.
What came next is, sadly, not surprising, given Mulvaney’s glaring conflict of interest: he scrapped tough new regulations aimed at protecting borrowers from payday loans. The CFPB shouldn’t need to regulate the industry (despite having been created in part to do so), he argued, because “[t]he best way to address the problem that you perceive is to pass legislation and not rely on me to do it for you.” Mulvaney, of course, knew full well that the Republican Congress in power at the time would never pass such legislation. Since his statements and regulatory changes to the industry, stocks for publicly traded payday lenders have shot up.
Around this time, the Community Financial Services Association of America, the trade group for payday lenders, booked its annual conference at Trump National Doral, a Miami golf resort that the Trump Organization bought out of bankruptcy in 2012 and renovated for $150 million with $125 million in loans from Deutsche Bank. Dennis Shaul, the leader of the trade group, claimed that golf and good weather motivated the decision to hold the conference at a Trump property, not politics—but, of course, there are plenty of nice golf resorts to choose from in Florida.
Generally, when you see economic systems that don’t seem to be maximizing value for society, you will find the corrupting influence of special-interest-group politics nearby. These special-interest groups and the politicians beholden to them are parasitically siphoning off value that should be going to consumers and citizens. Long before Trump became president, special-interest groups had been moving in the opposite direction from the utilitarian North Star.
Many industries lobby for their own interests in completely legal ways, including industries that don’t face media scrutiny. Consider the field of independent auditing (I know most readers find auditing to be a boring topic, but hang on). All developed economies believe that external parties (investors, strategic partners, etc.) need to be able to rely on a company’s financial reporting when making decisions and view independent auditing as a structure that enables them to do so. As then chief justice Warren Burger wrote in United States v. Arthur Young & Co. in 1984:
By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public. This “public watchdog” function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust.15
There are currently four firms large enough to audit the very largest corporations in society, after a fifth, Arthur Andersen, was forced to go out of business following its failure to notice Enron’s malpractices. The only reason for audit firms to exist is to provide independent audits, yet the auditing industry in the United States was set up in a manner that effectively eliminates independence in auditing. Auditing firms have financial incentives to avoid being fired by their clients. If an audit firm questions the client’s financials, the client has an incentive to find a new auditor, and the auditor loses a client. Audit firms also make significant additional profit from selling non-audit services (that is, consulting services) to their auditing clients, and individual auditors very often end up taking jobs with client firms. As a result, identifying problems with the client’s books can eliminate a career opportunity for the auditor. After a thorough investigation of these conflicts of interest, my colleagues and I long ago concluded that auditing firms do not live up to their promise of being independent.16
Creating the type of auditor independence needed to protect our financial markets would require that auditing firms only audit and not provide other services; that companies would regularly switch auditors; and that individual auditors would be barred from accepting positions with client firms for a set number of years.17 But we haven’t been able to get there, despite the value that such a proposal would create for society. The Sarbanes-Oxley Act of 2002 was intended to move in the direction of reform but was a weak attempt, watered down by political compromises. The primary reason we’re stuck with a corrupt system is the willingness of the large auditing firms to spend millions of dollars lobbying against reforms that would be good for investors, good for audited companies, and good for our financial system’s moral integrity. The only parties that have a long-term stake in keeping the current system in its current corrupt form are the four firms that currently provide services to the vast majority of large corporations.
These four firms work hard to send a false message about their ability to provide independent audits. In July 2000, just a little more than a year before the collapse of Enron, whose accounting irregularities Arthur Andersen failed to report, Andersen managing partner Joseph Berardino provided the following written testimony to an SEC hearing aimed at exploring measures to improve auditor independence:
The future of the [accounting] profession is bright and will remain bright—as long as the Commission does not force us into an outdated role trapped in the old economy. Unfortunately, the proposed rule [on auditor independence] threatens to do exactly that. A broad scope of practice is critical to enable us to keep up with the new business environment, attract, motivate and keep top talent, and thereby provide high quality audits in the future.
The testimony and lobbying of most of the Big Five audit firms kept the SEC from instituting reform, and it continues to do so to this day—even after Arthur Andersen’s demise due to its failure to provide exactly what Berardino promised.
What is fascinating and relatively unique about this story is that the auditing industry exists explicitly to help reduce corporate corruption, yet its own corrupt behavior prevents us from creating an auditing industry that could actually deliver on this promise. Ideally, government officials would make decisions that were in the best interest of the overall society, and it is hard to imagine that society would benefit from an auditing institution that fails in its mission to be independent. But in the United States, special-interest groups (including the auditing industry) lobby to write our laws and buy our politicians at levels that are unheard-of in the rest of the world.
This corruption has only increased since the Supreme Court’s 2010 Citizens United v. Federal Election Commission decision, which overturned restrictions on independent expenditures from corporations and labor unions for political communications and election spending. The infamous decision spawned the creation of so-called super PACs, which can accept unlimited contributions from corporations, unions, and other groups. Since then, campaign funding has increasingly shifted toward super PACs and “dark money” political nonprofits, unleashing unprecedented amounts of money to contort the laws in favor of special interests. Citizens and corporations in the United States may be more law-abiding than those in many other countries, yet no country has corrupted the lawmaking process at the level of the United States.18 But across nations, corruption has created rampant and unethical value destruction, regardless of whether laws are actually being broken.
CORRUPTION THROUGH MISINFORMATION
The tobacco and energy (most specifically coal and oil) industries may destroy more value than all other industries combined. Tobacco killed about 100 million people in the twentieth century and will kill many times that number in the twenty-first century. Climate change, exacerbated by coal and oil production, may ultimately kill more people than tobacco. Interestingly, the energy industry relies on misinformation methods very similar to those employed by the tobacco industry decades earlier. In our book, Blind Spots: Why We Fail to Do What’s Right and What to Do about It, Ann Tenbrunsel and I highlight the strategies that industries use to corrupt our understanding of science and destroy value in the process.19
Obfuscation
Corporations that want to delay societally beneficial reforms obfuscate, communicating in a deliberately confusing or ambiguous manner with the intention of misleading the listener. To avoid or slow down antismoking measures, the tobacco industry fomented confusion about the health effects of smoking for decades after finding out about the harm its products caused. While many oil companies pollute, Exxon Mobil was predominant in misleading the public by obfuscating the existence of climate change and the role of humans in creating the problem by burning fossil fuels. Big Tobacco and Exxon Mobil are well aware that obfuscation creates uncertainty—and that the public is less willing to invest in solving a problem whose existence or severity is uncertain than one that most certainly poses a significant threat.
Encouraging Reasonable Doubt
For forty years, from the 1950s to the 1990s, Big Tobacco maintained an explicit strategy of sowing doubt in the minds of smokers about the adverse health effects of cigarettes, long after there was scientific clarity about the causal role of cigarettes in lung cancer. Similarly, long after a clear consensus existed among scientists who were not being paid for their views, Exxon Mobil spent enormous amounts of time and money communicating to the public that some experts doubted the existence of climate change and, if it did exist, the role that humans played in it. Such carefully planted seeds of doubt make it difficult for politicians to act and for citizens to mobilize in support of reform.
Expressing Shifting Views of the Facts
To make a strong case to the public and politicians, corrupting forces insist upon their own distorted view of the “facts.” When their positions become untenable, they simply change their position and deny their past connection to claims that they now acknowledge, in the face of overwhelming evidence, to be clearly false. For decades, the tobacco industry held fast to the view that cigarettes caused no harm, and indeed might even achieve some positive health benefits, such as weight control, improved digestion, and relaxation. As the scientific connection between lung cancer and cigarettes mounted, industry executives grudgingly acknowledged that cigarettes might be one of many possible causes of lung cancer but insisted that no specific cancer could be traced to cigarettes and that the causal path was unclear. ExxonMobil made a relatively rapid shift in recent years: from insisting that man-made global warming did not exist, to claiming global warming is not caused by human actions, to arguing that it would not be worth the enormous costs to fix the problem. Maintaining the most reactionary view that is defensible and shifting their positions only out of necessity allows the enemies of wise policies to delay change and profit during the delay.
Maintaining the Status Quo
Psychologists have long known that, when contemplating a potential change, we tend to be more concerned about the risk of change than about the risk of failing to change. Imagine, for instance, that you receive an offer for a job that is much better than your current job on some dimensions (pay, responsibility, etc.) and marginally worse on others (location, health insurance, etc.). A rational analysis would imply that if the evident gains exceed the expected losses, you should accept the new job. However, the psychological tendency to pay more attention to losses than to gains will lead many to turn down the job, preserve the status quo, and forgo a net gain. Because losses loom larger than gains psychologically, the status quo creates inertia that is a barrier to wise action. The desire to maintain the status quo has a powerful impact on our decisions and interacts with the other obstructionist techniques I’ve described to keep society from acting.
What can we do to create value as citizens? We need to support politicians who accept science as a basis for policy and who are wise and brave enough to advocate to create value for society. We also need to support dramatic campaign finance reform. We should reward politicians who are ready to prevent corporations and industries from standing in the way of wise decisions for those they were elected to serve. We should elect leaders who will seek to punish organizations and industries that commit crimes that destroy value with the full power of the law.
EVERYDAY CORRUPTION
Most of the examples I’ve described in this chapter have involved truly egregious corruption. Notably, much of this behavior doesn’t break any laws; in many cases, the corruption occurs when corporations lobby for laws that benefit the few at the expense of broader society. I personally find each of the major stories that I have written about disturbing and disappointing. I am frustrated that our society allows these events to unfold as they do. The downside of focusing on these visible episodes, however, is that it is easy to distance ourselves from these corrupt acts and to assume that we are innocent ourselves. And, in many cases that confront us in ordinary life, corruption is not as clear or corrosive, yet still important.
In her book Cheating: Ethics in Everyday Life, Stanford law professor Deborah Rhode describes just how widespread cheating is in society, a phenomenon she illustrates with stories of cheating from the realms of sports, business, paying taxes, plagiarism, copyright infringement, insurance claims, and marriage.20 As you are thinking about any type of cheating you might have done in life, such as not reporting a small amount of income on your taxes or downloading a pirated video, note that it is common to rationalize these acts on the grounds that “everybody does it.” But note that these acts are more common and socially acceptable in some societies than in others. When we engage in them, we diffuse these corrupt acts by normalizing them.
To show how this normalization can happen, Rhode cites the repeated acts of corruption that have been documented in Trump’s businesses, including his development business and his $25 million settlement of a fraud case brought against Trump University. Only one-third of Americans believe that Trump is honest, yet he received 46.1 percent of the vote (Hillary Clinton received 48.2 percent). Collectively, we know he is corrupt, yet we seem to not care. This lack of concern about the corruption of our leaders is a problem, as it signals to the next generation of leaders that honesty is optional.
Attempting the difficult task of estimating the costs that cheating inflicts on society, Rhode comes up with a number of around $1 trillion per year in the United States alone. That figure includes $450 billion from the underpayment of taxes, $250 billion from illegal downloads, another couple hundred billion from insurance fraud, and anywhere from $50 billion to $200 billion from employee theft. These estimates are probably on the low side, given that people work hard to conceal their cheating. In any case, the real numbers are clearly huge. Not only do deserving parties fail to receive the funds they deserve, but the cheater becomes a lesser person as a result of his or her corruption. Perhaps most important, institutions that run the government, encourage innovation, enable insurance coverage, and so on are compromised.
FIXING CORRUPTION
Insurance is an unusually simple business. The basic idea is that you pay premiums regularly so that if something bad happens, you can submit a claim and receive a payment from the insurance company for the costs you incur. That’s it: pay money in the form of premiums, and receive money when you make a claim. The industry has no physical products to make or complex services to provide. Yet, walk around London, New York, or Zurich, and you will notice that insurance companies occupy very big buildings, sometimes multiple very big buildings. So, what are all the employees inside doing? Based on my experience, many are spending a great amount of time not paying claims.
That’s right—I said not paying claims. Large insurers often dedicate thousands of employees to assessing and negotiating with claimants, with a focus on paying less money than the claimant requested (or demanded). Why not pay the claim? The insurance adjusters are quick to explain that it is because people lie—and sometimes lie a great deal. They add items to their list of what was stolen and exaggerate the value of items. They overstate their injuries. Fraud is a major problem confronting the insurance industry, and insurance firms spend many millions of dollars each year on fraud detection. Meanwhile, if you ask claimants why they are asking for more than the objective value of the claim, they are likely to reply that the insurance company views the claim as a starting point for negotiation, and if you are honest, you will end up with less than the objective value of the claim. Thus, both sides end up acting in a corrupt manner to counter the expected corruption of the other side. One large insurance company that I know well devotes about three thousand claims adjusters and spends about $3 billion (yes, billion) on external legal fees to pay about $30 billion in claims. All of this hassle, cost, and value destruction is caused by mutually destructive corruption. Is this “just the way it is,” or can something be done to create value?
As I was getting to know the insurance industry while consulting with one of the world’s largest insurers, I was also the fifth author on a paper that starts with the words “Signing at the Beginning . . .”21 Think about the tax form you fill out annually, or any expense reimbursement forms you’ve filled out in the past. You’ll remember that after filling out such forms, you’re typically asked to sign your name to attest that you completed the form honestly. In this initial paper on signing first, my coauthors and I found that if people promise to tell the truth before filling out a form—that is, at the top of the form rather than the bottom, or on the first screen of an online form rather than the last—they fill out the form far more honestly than if they sign it after.
The paper was published in the Proceedings of the National Academy of Sciences (PNAS), not exactly the best place to get the attention of start-up entrepreneurs or insurance executives.22 Making matters worse, we recently failed to replicate this result, reducing my confidence in the conclusion of the paper.23 However, I did receive an email from a start-up insurance executive by the name of Stuart Baserman, who had read the original PNAS article. Stu had an interest in getting people to tell the truth online. Stu is low-key, but based on our nearly identical and rather uncommon last names and the topic of my paper, his spouse, Sue, pushed him to send me an email, which led to a friendship and a work relationship.
Stu is the cofounder of a company called Slice.24 If you go to their website, you will see that they are in the business of selling short-term insurance to people who rent out their homes on Airbnb or Homeaway. The insurance covers the residential property when it’s being used for commercial purposes. Most relevant, Slice sells the vast majority of its policies online and handles claims online. In the process, Slice has become a leader in helping large companies think through how to sell policies and pay claims online with far greater efficiency than the traditional model. Slice can handle claims at a far lower cost than traditional insurance firms. But, it may have occurred to you that claimants might be more likely to lie in an online world?
That’s where I came in. After Stu contacted me, thinking that I might know something about how to get people to tell the truth, Slice hired me as a consultant to help devise the claims process in a manner that would reduce fraud. Imagine a world where claimants told their insurance company the truth, and the company honestly paid the claim. Most of the $3 billion that at least one company has been spending on legal fees wouldn’t be needed. Thousands of claims adjusters could be replaced by tens of claims adjusters. Claims could be paid far faster, and claimants (often also called customers) could be far happier with their insurance provider.
How to create this utopian world of insurance? To start with, the goal isn’t complete honesty—any more than our goal in this book is to be perfect—but rather far less corruption than occurs currently. In addition, like so many other aspects of today’s economy, insurance will need to move onto the cell phones that govern so much of the rest of our lives. What would be key ingredients to the online claims service? Slice is still working on it, but here are some hints.
First, very good artificial intelligence (based on past claims and other aspects of claimants’ lives that can be found online) would be used to identify the small portion of claims that are actually completely fraudulent. Next, when a customer incurs an insured loss, she would simply open up the app on her phone and fill out a claim form. She would commit to telling the truth before filling out the rest of the form, in order to induce an honesty mindset. In addition, the claimant would be asked to create a very short video using her phone’s camera describing her claim as simply as possible. Why? Because people are far less likely to lie in a video than when writing or typing. Claimants would then be asked specific, verifiable questions about the loss, such as “What did you pay for the lost object?” or “What does it cost to replace it on Amazon.com?” rather than “What was it worth?” That’s obviously because more general questions allow people to provide more ambiguous answers, which are more likely to be deceptive. Next, claimants would be asked who else knows about the loss (such as a guest who was in the house when the loss occurred). People are less likely to be deceptive when their corruption could be communicated to others. Assuming the artificial intelligence assesses the claim to be trustworthy, the typical claim would then be paid within moments, thanks to an automated payment system. By paying claims so honestly and efficiently, the insurance company will gain a reputation for being trustworthy, and, thanks to the psychology of reciprocation, customers will be more honest in return. The goal is to create a fundamentally more competitive insurance product that is better for honest customers and better for the insurer as well—true value creation.
I feel fortunate to have had the opportunity to spend my time trying to reduce corruption on a potentially broad scale. I like the idea of helping to create a more honest insurance system. But there is much that all of us can do to create value by reducing corruption. One obvious step is to avoid the temptation to be corrupt, even when everyone else is doing it. But, given that you are probably pretty honest, or you wouldn’t have read this far in this book, you probably have bigger opportunities to notice and act when others are being corrupt. Elsewhere, I have written in detail about Bernard Madoff’s Ponzi scheme, which involved him stealing tens of billions of dollars from unsuspecting investors.25 For me, the most interesting part of the story is not that a really bad guy did bad things, but that hundreds of bright, well-educated people had the data in front of them showing that Madoff’s returns were impossible, but didn’t notice and act on this information. So, in the future, when you see something that seems off or too good to be true, remember your obligation to speak up and make the world a better place.