Merchants often perceive fraud insurance as a solution in their battle against fraud and policy abuse. However, this perception masks the reality that fraud insurance is a false economy, diverting attention from proactive protection measures and failing to address the root causes of fraudulent activities.
Here, Aaron Begner, EMEA general manager at fraud prevention company Forter, delves into the economics of fraud insurance and highlights its limitations.
Begner, with over 14 years of experience in account management and e-commerce technology solutions, argues that fraud insurance fails to address the root causes of fraud, diverts focus from proactive business protection, and compromises customer experience.
Merchants are overpaying in the fight against fraud and policy abuse. As they navigate this period of immense economic uncertainty – that’s driving a rise in fraud rates – the battle to protect the bottom line is all-consuming. But fraud insurance is the wrong weapon to bring to the fight; in fact, it’s not a weapon at all.
Fraud insurance does nothing to discourage or tackle the root causes of fraud and policy abuse, it is merely a costly sticking plaster. It is a false economy that diverts merchant focus from proactively protecting their business and maximising conversions, to their fraud insurance vendor’s goal of avoiding chargebacks at all costs, even at the expense of good customers.
On the face of it, fraud insurance is a seductive solution. The insurance vendor takes liability for chargebacks, returns abuse, item not received (INR) abuse and the other myriad ways fraudsters and policy abusers seek to take unfair advantage. It’s a weight off the merchant’s shoulders, providing assurance that they won’t lose out financially in the event they are targeted.
But that is a simplistic (although comforting) view that obscures the real economics and limitations of fraud insurance schemes. As conditions become increasingly challenging, it is vital that merchants square up to fraud with a stronger arsenal of intelligent tools that deliver greater control and visibility, power abuse prevention – and also cut costs in the process.
Charge of the chargebacks
There’s no question that chargebacks are a growing problem. In 2022, around one-quarter of e-commerce shoppers disputed at least one charge, and the trend is set to continue as consumers feel the pinch. Also feeling the pinch are card issuers, who are responding to rising chargeback rates by increasing the detail and granularity of evidence that can be submitted to prove a cardholder knowingly participated in a disputed transaction.
But the burden and cost of dispute administration is rising as a result, making it tempting to hand off the problem to a fraud insurance provider offering a chargeback guarantee. However, this often has unintended consequences due to the motivations driving the insurer’s actions.
Compromised customer experience and rising fraud rates
It is in the interests of an insurer underwriting the cost of chargebacks to reduce the rate of chargebacks. However, this is often achieved by declining more transactions at the point of sale. So, while chargeback rates and the cost to the insurer reduce, many more genuine customers see their transactions falsely declined. This compromises customer experience, directly impacting revenues and ultimately causing long-term brand damage at a time when every sale counts.
Nor is a fraud protection reimbursement policy the simple solution many vendors claim. It typically requires the merchant to provide data from diverse sources such as proof of shipment, tracking numbers, proof of address match and more – all in a short time frame and formats dictated by the vendor. The burden on the merchant is considerable.
It’s important to note that there is even less value in merchants purchasing chargeback insurance in Europe. This is due to the liability in many transactions shifting to the card issuer through an additional layer of Secure Customer Authentication in the form of mandated 3DS. Therefore, paying a premium for chargeback insurance where it is largely not required, due to the presence of 3DS, is superfluous.
Putting your faith in fraud insurance may also elevate long-term risk. As fraud rates rise, and they are forced to take on customers operating in higher-risk industries, chargeback guarantee companies are facing declining revenues. As their margins take a hit, so does their ability to support existing customers, deliver on service levels and invest in the innovation required in this volatile market to stay ahead of sophisticated fraudsters. Ultimately, it may prove an existential problem that could leave policy-holders in the lurch should the business fail.
Transferring policy abuse risk doesn’t solve its root causes
Perhaps most importantly – from the perspective of building more resilient, viable businesses over the long term – is the fact that fraud insurance simply kicks the can down the road. It doesn’t discourage or stop repeat returns abuse, and INR abuse offenders.
Much like how cybercriminals repeatedly ransom companies that they know will pay up because they have ransomware insurance in place, policy abusers will keep taking advantage of businesses that make it ‘easy’ to make a quick buck. But, as has proven the case with ransomware insurance, the insurance policy premium will ultimately rise.
“It’s time to rip off the sticking plaster and tackle fraud risk head-on.”
And, with policy abuse remaining unchecked, if the business wants to take on liability at a future date, it will be facing a much larger problem. Ultimately, it may reach a level that prevents the business from shouldering liability, leaving it locked into an unhealthy relationship with the insurer. That’s why it’s better to address the issue now, before the situation worsens.
Unpacking the economics of fraud insurance
Taking on liability for fraud and policy abuse might seem a daunting prospect, but when we break it down in relation to the typical cost of fraud insurance, the numbers tell a different story.
For example, you could invest in better technology to actually address the root cause, resulting in better management of policy abuse, at a cost of around £1million per year, and retain liability for £2million in chargebacks, or you could pay a fraud insurance provider £10million per annum for a chargeback guarantee with the likelihood that the premium will rise year on year. Suddenly, £3million looks like a bargain, and helps deliver cost reduction to the company.
Switch up fraud strategy with a combined management and chargeback solution
You may be fully onboard with the need to stop putting money in insurance vendors’ pockets and start tackling the root causes of fraud and policy abuse, but few businesses will be confident enough to rip the chargeback guarantee plaster off in one go. However, a combined fraud management and chargeback dispute solution can be the first step, maximising the potential to fight fraud and abuse while simplifying the submission of chargeback claims and allowing more genuine transactions to be approved.
A combined solution leans on technology to tackle the root causes of the problem. Policy abuse, for example, can be identified, deterred, and blocked with the right technology platform. One that can adapt purchase conditions in real time for suspected repeat offenders, to add a delivery signature, for example.
When it comes to the issue of balancing chargeback risk against approval rates, most insurance vendors will offer a covered agreement to manage chargebacks which, as mentioned earlier, tends to result in higher decline rates as they seek to minimise their exposure. By choosing an uncovered solution, the business can take a more nuanced view that optimises business outcomes by allowing more transactions, supported by intelligent customer identity and behaviour analysis.
Finally, by leveraging the automation potential that a fraud management platform offers, the burden of managing chargebacks is reduced. From recommending which chargebacks to fight, to automatically collating evidence from multiple disparate systems and generating letters for seamless submission to processors, a large amount of administration can be eliminated through automation.
Protecting the bottom line has never been more important, but to truly build business resilience over the long term, organisations must take a proactive stance on fraud and policy abuse prevention. This can’t happen while they are leaning on the costly comfort blanket of fraud insurance. It’s time to rip off the sticking plaster and tackle fraud risk head-on.