What is Chargeback Insurance and Will it Solve Your Chargeback Problems?
Chargeback insurance sounds like a pretty sweet deal, doesn't it?
Insurance that protects you against chargebacks the same way fire insurance protects you from fire damage, or collision insurance reimburses you in the event of an accident? What's not to love about that?
On the surface, chargeback “insurance” hints at a program to help safeguard policyholders’ financial interests when unforeseen (chargeback) events occur. Dig a little, however, and you'll quickly see that the reality doesn't measure up to the hype.
Insurance Vs. Warranty
(Hint: neither is what you expect)
Most merchants are interested in securing chargeback insurance because they think it will cover any chargebacks they receive. And in truth, there are products on the market that are beneficial in helping merchants avoid a portion of chargeback liability. Here's where things start getting confusing, though.
What you probably think of as chargeback insurance could more accurately be called a chargeback warranty. While the terms are often used interchangeably—even by those who should know better—they're two very different things.
Traditional chargeback insurance is a policy that protects acquiring banks. Acquirers obtain chargeback insurance in case a merchant goes out of business while still owing chargeback costs and fees. Obviously, there's nothing wrong with that…but it's not much help for you as a merchant.
(sometimes referred to as chargeback insurance) In theory, these policies reimburse you in the case of fraudulent chargebacks. While it sometimes works as intended, you’re in for an unpleasant surprise if you purchase such a policy assuming it provides complete protection.
How Does It Work?
A chargeback warranty usually relies on the use of front-end fraud filters. These tools check each transaction against preset criteria, flagging those considered potentially fraudulent for manual review. At that point, you generally have three options:
- Simply accept the conclusion of the fraud filter and cancel any transactions deemed “high-risk;” this will inevitably lead to false positives, which means turning away valid customers.
- Take the time to manually contact each customer associated with a flagged purchase. This allows the you to eliminate most false-positives, but it is extremely labor-intensive.
- Completely ignore any red flags and process all transactions as valid.
One might assume that option #3 offers the best of all worlds: there's no danger of reacting to false positives, and any genuine fraud that causes a chargeback will be covered by insurance…right? Well, not necessarily.
What Chargeback Insurance Won’t Cover
Remember: a typical chargeback warranty is, first and foremost, a fraud filter. This creates two distinct problems:
- Since insurance only applies if a chargeback is filed, it is in the provider's best interest to set the parameters of the filter much higher. This will catch more fraud, but it can also dramatically increase false positives.
- Not all policies allow for manual review; of the policies that do allow it, some void coverage on transactions flagged by the system, but later approved through manual review.
There are some instances where these policies work well; for example, purchases made with a lost or stolen credit card, or with a counterfeit card or account number, will almost always be covered. But the highest percentage of an average merchant’s chargebacks—those resulting from friendly fraud—are unlikely to be covered at all.
In many cases, you will receive better ROI working with a straightforward fraud filter provider; it’s effectively the same product, but more adaptable to the specific needs of your business.
Solving a Problem That Doesn't Exist
The biggest question when considering any type of chargeback insurance is simple: Will it really help?
Because of the cost involved, you’re unlikely to see a decent ROI on purchases less than $300. The bulk of policies also don't cover chargebacks resulting from situations you could have potentially resolved, such as if an item arrived broken, or never arrived at all. Chargebacks caused by errors aren't covered, either.
In fact, chargeback insurance essentially only covers one thing: chargebacks resulting from clear, deliberate criminal fraud. But criminal fraud commonly accounts for the fewest cases of chargeback fraud (less than 10% on average). Most fraudulent chargebacks are directly tied to friendly fraud which, as mentioned above, will not be covered.
In other words, chargeback warranties are more or less set up to solve a problem that doesn't exist.
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Even when your policy does cover a chargeback, there are other costs to consider. Depending on the policy, you will likely still have to pay for all chargeback and administration fees stemming from insured transactions (this can range anywhere from $20 to $100 per dispute).
Additionally, insurance can’t alter your business's overall chargeback ratio. You might be reimbursed for lost profits, yet still be saddled with a higher percentage of chargebacks received. Over the long term, this could lead to your business being labeled as high-risk…or losing processing rights altogether.
Prevention is Better Than Insurance
To boost the protective power of merchant chargeback insurance, some businesses also contract with a chargeback protection service. Chargeback protection organizations maintain a database of shoppers who have initiated a chargeback in the past. Merchants can review this information before accepting a credit card payment, helping reduce the chances of fraud.
Fraud filter companies provide this service either through a gateway application or an after-market digital review. While still requiring work on the merchant's part, it can be an effective prevention method for chargebacks, especially when combined with a chargeback warranty.
While chargeback insurance policies do have their benefits, you shouldn't rely too heavily on them. Behind the scenes, what is touted as chargeback insurance is simply underwriting a handful of potential chargebacks the provider takes the time to manually review or analyze on your behalf.
Ultimately, chargeback insurance can help prevent some potential revenue loss, but this must be balanced against the cost of the program, as well as sales lost to false positives. The best way to insure your company against chargebacks is to employ a long-term strategy that works to eliminate credit card transaction disputes. Click below to learn more.